BCAJ | Bombay Chartered Accountant Journal

S. 22 and S. 24 of the Income-tax Act, 1961 — Rent, being only a surrogate measure of annual value, has to be reduced by the expenses not connected with property but incurred by landlord for enjoyment of property by tenants, such as salary and bonus to sw

New Page 1

(2009) 120 TTJ 1127 (Ahd.)

J. B. Patel & Co. (Co-owners) v. Dy. CIT

ITA No. 4033 (Ahd.) of 2004

A.Y. : 1993-94. Dated : 29-2-2008

S. 22 and S. 24 of the Income-tax Act, 1961 — Rent, being
only a surrogate measure of annual value, has to be reduced by the expenses
not connected with property but incurred by landlord for enjoyment of property
by tenants, such as salary and bonus to sweeper, pumpman and liftman and
electricity charges for pump motor and common passage.

For the relevant assessment year, the assessee computed
rental income under ‘Income from House Property’ after claiming deductions in
respect of the following expenses :

(a) Salary and bonus paid to sweepers/pumpman/liftman

(b) Electricity charges for pump motor and common
passage.

Since these expenses were not covered by S. 23 and S. 24,
the Assessing Officer denied the assessee’s claim. The disallowance was upheld
by the CIT(A).

The Tribunal, deciding in assessee’s favour, noted as
under :

(1) The rent being charged by the assessee is only a
surrogate measure of the said annual value. The expenditure on the aforesaid
items, i.e. the salary (including bonus) to the maintenance staff of
the facilities such as electric motors, lift, cleaning, etc., as well as
that on the electricity consumed in respect of any common area and the
electric motors, is not attributable directly to the house property as such,
but to its enjoyment by the tenants/users thereof.

(2) In a given case it may happen that the said
expenditure is incurred by the tenant or tenants (collectively), with the
landlord having no locus standi or role therein. Who incurs the expenditure
in the first instance is only a matter of mutual arrangement or convenience
and thus, of no consequence where the bona fides of such expenditure are, as
in the present case, not in doubt. The rent being charged by the assessee,
which represents the measure of its annual value, would, in such a case
stand correspondingly reduced.

(3) As such, although the assessee, being entitled only
to the deductions in respect of the said expenditure in the computation of
income under the said head of income only in terms of its provisions, would
not be entitled to the impugned deductions, we consider that the annual
value of its house property be assumed at the reduced value, i.e.
after deducting the impugned amounts (from the rental), being only in
relation to the expenditure required to be necessarily incurred for the
enjoyment/user of the relevant property and, therefore, can only be
considered as having been included at the said amount, i.e. at cost
by the two parties in the determining of the rental.

(4) The standard deduction admissible to the assessee on
account of repairs @ 1/6th of the annual value of its house property is in
relation to the repairs, whether actually incurred or not, by the assessee
during the relevant year. The impugned sums are not in relation to any
repairs to the house property, but for the maintenance of the facilities
enjoined therewith and necessary for its useful enjoyment.

levitra

Nirav Shah

S. 143(1) and S. 263 of the Income-tax Act, 1961 — Provisions of S. 263 are not applicable where only intimation u/s.143(1) has been issued.

New Page 1

(2009) 120 TTJ 1009 (Agra) (TM)

Vinod Kumar Rai v. CIT

ITA No. 234 (Agra) of 2005

A.Y. : 2002-03. Dated : 21-11-2008

S. 143(1) and S. 263 of the Income-tax Act, 1961 —
Provisions of S. 263 are not applicable where only intimation u/s.143(1) has
been issued.

For the relevant assessment year, the CIT passed a revision
order u/s.263 in respect of the return of income processed u/s.143(1). Before
the Tribunal, the assessee contended that the processing u/s.143(1) is neither
an assessment nor an assessment order and the same cannot be subjected to
revision u/s.263 and the revision order made by the CIT may, therefore, be
declared as bad in law.

On account of difference of opinion between members of the
Bench, the matter was referred to the Third member u/s.255(4).

The Third Member held in favour of the assessee. The Third
Member noted as under :

(a) After an intimation u/s.143(1) is issued, the
Assessing Officer had full power to issue a notice u/s.143(2) and make a
regular assessment u/s.143(3). The Assessing Officer could also proceed
u/s.147/148, if applicable.

(b) There was no explanation as to why these provisions
were not applied in this case.

(c) Various High Courts in India are not unanimous
whether provisions of S. 263 are applicable where only intimation u/s.143(1)
has been issued, whether such intimation is an order or assessment to
attract provisions of S. 263. The Supreme Court, at an appropriate time,
will take up and settle the issue.

(d) It is clear from the record that two reasonable views
of the matter are possible. In such a situation, it has been laid down by
the Supreme Court in numerous cases that the view which is favoring the
assessee has to be taken.

Therefore, it was held that the intimation u/s.143(1)
cannot be sought to be revised u/s.263.

levitra

Nirav Shah

S. 32 of the Income-tax Act, 1961 — Commercial right comes into existence whenever the assessee makes payment of non-compete fee and such non compete right is an intangible asset eligible for depreciation.

New Page 1

(2009) 120 TTJ 983 (Chennai)

ACIT v. Real Image Tech. (P) Ltd.

ITA No. 201 (Mad.) of 2007

A.Y. : 2001-02. Dated : 15-2-2008

S. 32 of the Income-tax Act, 1961 — Commercial right comes
into existence whenever the assessee makes payment of non-compete fee and such
non compete right is an intangible asset eligible for depreciation.

During the relevant assessment year, the non-compete fees
paid by the assessee in pursuance of non-compete agreements entered into by it
with certain companies was claimed as revenue expenditure and the claim was
disallowed by the Assessing Officer. Under an application to the Joint CIT
u/s.144A, the assessee made an alternate plea for treating such fees as
capital expenditure — it should be treated as an intangible asset u/s.32 and
depreciation be allowed accordingly. The Jt. CIT did not allow the same,
holding that the payment was capital in nature i.e. neither a revenue
expenditure nor a capital expenditure. The CIT(A) allowed the assessee’s
claim.

The Tribunal, relying on the decisions in the following
cases, allowed the assessee’s claim for depreciation :

(b) ACIT v. Radaan Media Works India Ltd., ITA No.
2241 (Mad.) of 2006 dated 14-12-2007

(c) Techno Shares & Stocks Ltd. v. ITO, (2006) 101
TTJ 349 (Mum.)

The Tribunal noted as under :

(1) When a businessman pays money to another businessman
for restraining the other businessman from competing with the assessee, he
gets a vested right which can be enforced under law and without that the
other businessman can compete with the first businessman.

(2) When by payment of non-compete fee, the businessman
gets his right what he is practically getting is kind of monopoly to run his
business without bothering about the competition.

(3) Generally, non-compete fee is paid for a definite
period which in this case is five years. The idea is that by that time the
business would stand firmly on its own footing and can sustain later on.
This clearly shows that a commercial right comes into existence whenever the
assessee makes payment for non-compete fee.

(4) The term ‘or any other business or commercial rights
of similar nature’ has to be interpreted in such a way that it would have
some similarities as other assets mentioned in clause (b) of Expln. 3. The
other assets mentioned are know-how, patents, copyrights, trade marks,
licences, franchises, etc. In all these cases no physical asset comes into
possession of the assessee. What comes in is only a right to carry on the
business smoothly and successfully and, therefore, even the right obtained
by way of non-compete fee would also be covered by the term ‘or any other
business or commercial rights of similar nature’ because after obtaining
non-compete right, the assessee can develop and run his business without
bothering about the competition. The right acquired by payment of
non-compete fee is definitely an intangible asset.

(5) This right (asset) will evaporate over a period of
time (of five years in this case) because after that the protection of
non-competition will not be available to the assessee. This right is subject
to wear and tear by the passage of time, in the sense that after the lapse
of a definite period of five years, this asset will not be available to the
assessee and, therefore, this asset must be held to be subject to
depreciation.

levitra

Nirav Shah

S. 56(2)(v) of the Income-tax Act, 1961 — Interest-free loan obtained by assessee from sister concerns for purchase of a flat from one of them cannot be said to be without consideration because while the assessee was benefited by interest-free loan, lende

New Page 1

(2009) 121 TTJ 145 (Mumbai)

Chandrakant H. Shah v. ITO

ITA No. 3966 (Mum.) of 2008

A.Y. : 2005-06. Dated : 12-1-2009

S. 56(2)(v) of the Income-tax Act, 1961 — Interest-free
loan obtained by assessee from sister concerns for purchase of a flat from one
of them cannot be said to be without consideration because while the assessee
was benefited by interest-free loan, lenders were benefited by profit embedded
in the sale consideration, hence not exigible to tax u/s.56(2)(v).

During the relevant assessment year, the assessee took
interest-free loans of Rs.54.70 lacs from four builders (sister concerns) for
purchasing a flat from one of them. The assessee was also employed with one of
the concerns. The Assessing Officer formed an opinion that the assessee was
working with the group for several decades and, hence, having regard to the
said association, these parties gave such a huge loan to the assessee without
any security and interest as a mark of gratitude irrespective of his repayment
capacity and, therefore, in the absence of any obligation on the part of the
assessee to repay these loans, the entire transaction was of the nature of
gift which was given a colour of loan. Accordingly, he added a sum of Rs.54.45
lacs after giving a rebate of Rs.25,000 u/s.56(2)(v) to the total income of
the assessee.

The CIT(A) held that such loan transactions were abnormal
in the sense that there was no interest or any repayment stipulation, and
hence, the said sums were without consideration and upheld the addition.

The Tribunal, relying on various decisions, deleted the
addition.

The Tribunal noted as under :

(1) All these loans have been shown in the balance sheet
submitted along with the return of income as loans and the lenders have also
confirmed the same as such. Thus, apparently, it is a case of loan
transactions and not a case of gift.

(2) Since some of the loans were repaid partly/fully, it
was a material fact so as to rebut the presumption of the Assessing Officer
that the assessee was not under any obligation to repay the loans and this
fact also proves the assessee’s claim that no opportunity was granted by the
Assessing Officer to the assessee before making such addition.

(3) This type of addition also leads to a situation of
having two provisions for charging one type of income i.e. the
legislature has provided two charging sections i.e. S. 68 and S. 56
(2)(v) which cannot be possible. In that case, the legislature would have
made the provisions of S. 56(2)(v) either of overriding nature by stating
that ‘notwithstanding anything contained in S. 68’ or by providing for
applicability of provisions of S. 56(2)(v) in any other manner, in case
provisions of S. 68 could not be invoked. When a specific provision exists
in law for a particular thing, then that thing is liable to be examined
thereunder only and if that item cannot be taxed under that provision, then
that thing cannot be charged to tax under other provisions of the Act.

(4) In the present case, it is not that provisions of S.
68 were not applicable at all and, hence, the Assessing Officer invoked the
provisions of S. 56(2)(v). On the contrary, the Assessing Officer has made
necessary enquiries in that regard and he has not made addition u/s.68 for
the reason that all the requirements of that section i.e. identity,
creditworthiness and genuineness of transactions have been proved. Hence, a
loan transaction has to be treated as a loan transaction only and it should
be examined in the light of provisions of S. 68 and not under provisions of
S. 56(2)(v) and for this reason alone, this addition is liable to be
deleted.

(5) It is important to note that in S. 56(2)(v), the term
‘consideration’ is neither prefixed by the word ‘adequate’ nor it is
suffixed by the words ‘money or money’s worth’. Hence, if in any transaction
there exists consideration as per the provisions of the Indian Contract Act,
1872 such transaction would not come into the ambit of this section.

(6) Consideration for a promise may consist of either
some benefit conferred on the promisor or detriment suffered by the promisee
or both. Hence, on this criteria, the assessee has gained by way of
interest-free loan and the lenders have suffered by giving interest-free
loans and such suffering has got some value and, therefore, the said
transaction cannot be said to be without consideration.

(7) There is another very important aspect of the matter,
i.e. lenders have sold the flat to the assessee. In that sale
consideration, they have earned profit because it is nobody’s case that the
flat to the assessee has been sold at cost. Therefore, lenders have also
derived some benefit which has got value and, therefore, the same forms
consideration for giving interest-free loans to the assessee. Other three
lenders are the sister concerns of the company who actually built or sold,
hence the benefit derived by such company is a good consideration for other
three lenders. Benefit conferred to a third party not connected with the
promissor or promise in a pecuniary capacity would also be a good
consideration to support the transaction. There can be consideration without
any apparent monetary consideration and the only requirement is that the
consideration should create a legal relationship between the contracting
parties and this fact is not in dispute in the present case. Hence, the
transaction is with consideration. The term ‘consideration’ in legal sense,
is somewhat different from what is generally understood and the Revenue’s
decision is based on general understanding and, therefore, the same is not
correct in law. The transaction meets all the requirements of general law
which is only to be looked into while invoking provisions of S. 56(2)(v)
and, therefore, it is a transaction having a consideration and, therefore,
the same does not fall within the ambit of the provisions of S. 56(2)(v) for
this reason also.

levitra

Nirav Shah

S. 14A and S. 48 of the Income-tax Act, 1961 (i) Interest on funds borrowed for acquisition of shares is to be taken into account towards the cost of acquisition for the purpose of computation of capital gains as prescribed u/s.48(ii)

New Page 1

(2009) 120 TTJ 397 (Pune)

Balan alias Shanmugam Balkrishnan Chettiar v.
Dy. CIT

ITA No. 1859 (Pune) of 2005

A.Y. : 2002-03. Dated : 31-1-2008

S. 14A and S. 48 of the Income-tax Act, 1961 :

(i) Interest on funds borrowed for acquisition of
shares is to be taken into account towards the cost of acquisition for the
purpose of computation of capital gains as prescribed u/s.48(ii)

(ii) Capital gain on the sale of shares being part of
the total income of the assessee and not an exempt income, S. 14A has no
application.

For the relevant assessment year, the Assessing Officer and
the CIT(A) disallowed the assessee’s claim for inclusion of interest paid on
funds borrowed for investment in shares in the cost of acquisition for the
purpose of computing capital gains.

The Tribunal, relying on the decisions in the following
cases, held in favour of the assessee :

(a) CIT v. Mithilesh Kumari, (1973) 92 ITR 9
(Del.)

(b) Addl. CIT v. K. S. Gupta, (1979) 119 ITR 372
(AP)

(c) CIT v. Maithreyi Pai, (1984) 43 CTR 88 (Kar.)/
(1985) 152 ITR 247 (Kar.)

The Tribunal noted as under :

(1) In the past, the assessee had always capitalised the
interest.

(2) S. 48 says that capital gain is to be computed by
deducting from the consideration the cost of acquisition of the asset and
the cost of any improvement thereto.

(3) Once it is established that the assessee had borrowed
the funds for acquisition of shares and the burden of interest had been
capitalised, that interest burden cannot be segregated from the amount of
investment.

In response to the argument of the Revenue that since
interest had a nexus to exempt income, the provisions of S. 14A should be
applied, the Tribunal noted as under :

(1) The words ‘in relation to income which does not form
part of the total income under this Act’ mean if an income does form part of
the total income, then the related expenditure is out of the ambit of the
applicability of S. 14A. The capital gain shown by the assessee had formed
part of the total income of the assessee. Otherwise also, capital gain is
not exempt income and without any ifs and buts, always being taxed in the
hands of a taxpayer. Therefore, the Revenue authorities have proceeded on a
wrong premise that the interest expenditure was in respect of an income
which was exempt or did not form part of the total income.

levitra

Nirav Shah

S. 28(i) and S. 45 of the Income-tax Act, 1961 — Profit from sale of shares out of investment portfolio was taxable as capital gains and not as business income.

New Page 1

(2009) 120 TTJ 216 (Luck.)

Sarnath Infrastructure (P) Ltd. v. ACIT

ITA No. 301 (Luck.) of 2006

A.Y. : 2004-05. Dated : 20-12-2007

S. 28(i) and S. 45 of the Income-tax Act, 1961 — Profit
from sale of shares out of investment portfolio was taxable as capital gains
and not as business income.

The assessee-company was dealing in shares both as business
as well as investment and keeping separate accounts in respect of the two
portfolios. Valuation of holdings in investment portfolio was done at cost
only and holdings were reflected in Balance Sheet as investment. For the
relevant assessment year, the profit on sale of shares out of the investment
portfolio was treated by the Assessing Officer as business income and not as
long term capital gain. The CIT(A) upheld the addition.

The Tribunal held that the said profit was to be treated as
long term capital gain and not as business income. The Tribunal’s decision was
arrived at after examining various decisions.

The Tribunal noted as under :

(1) The material on record showed that the assessee had
clear independent portfolios for investment in shares as well for trade and
it has kept separate accounts in respect of the two portfolios.

(2) The shares which were sold out of investment
portfolio during this year and on which capital gains have been offered by
the assessee were held by it for more than two years and in some cases for
more than three years.

(3) No material is brought on record by the Department to
show that demarcation line between business and investment is hazy or that
assessee has not maintained an investment portfolio and it was dealing in
shares only like a trader.

(4) Valuation of holdings has been done at cost for
investment portfolio. They were reflected in the Balance Sheet as
investment.

(5) The frequency of such purchase or sale in this
portfolio is not large enough to doubt that the investment portfolio is only
a device to pay lesser taxes by parking some stock-in-trade in the
investment portfolio.

(6) Turnover to stock ratio in investment portfolio is
very low as compared to that in trading portfolio. Further, there is no
material to show that these shares in the investment portfolio were also
traded in the same and like manner as those which were in stock-in trade
portfolio.

(7) All the sales out of the investment portfolio were
identifiable to purchases made in the same portfolio.

(8) In view of the above facts, the assessee had
discharged its primary onus by showing that it was maintaining separate
accounts for two portfolios and there was no intermingling. The onus then
shifted on the Revenue to show that apparent was not real. There was no
material brought in by the Revenue to show that separate accounts of two
portfolios were only a smoke screen and there was no real distinction
between the two types of holdings. This could have been done by showing that
there was intermingling of shares and transactions and the distinction
sought to be created between two types of portfolios was not real but only
artificial and arbitrary.

Therefore, in absence of any material to the contrary and
on appreciation of cumulative effect of several factors present, it was held
that the surplus was chargeable to capital gains only and the assessee was not
to be treated as trader in respect of sales and purchases of shares in the
investment port-folio.

levitra

Nirav Shah

Income-tax Act, 1961 — S. 194A — Whether a chit fund agreement is not a money lending contract but a special type of contract — Held, Yes. Whether in a scheme of chit fund there is neither any money borrowed nor any debt incurred, the dividends paid by th

New Page 1

2009 TIOL 328 ITAT (Bang.)

ITO v. Margasoochi Chits Pvt. Ltd.

ITA No. 995/Bang./2008

A.Y. : 2005-2006. Dated : 16-1-2009

Income-tax Act, 1961 — S. 194A — Whether a chit fund
agreement is not a money lending contract but a special type of contract —
Held, Yes. Whether in a scheme of chit fund there is neither any money
borrowed nor any debt incurred, the dividends paid by the foreman to the
subscribers of the chit cannot be said to be answering the definition of
interest — Held, Yes.

Facts :

In these cases the AO relying on the instructions issued by
CBDT held that the dividend payments made to the subscribers of chit fund were
in the nature of interest and were liable for deduction of tax at source
u/s.194A. Since the assessees had not deducted tax u/s.194A, the AO passed
orders u/s.201(1) and u/s.201(1A) in respect of five assessees for the
impugned assessment years by creating demand on the dividends paid but not
subjected to tax deduction at source. Since identical orders were passed in
all the fifteen appeals they were taken up together by the Tribunal.

The CIT(A) held that a chit agreement is not a money
lending contract, but a special type of contract and any payment with
reference to a chit agreement being referred to as interest payment does not
arise and installments in chit fund being non-refundable in nature cannot be
equated with ‘deposit’ and consequently, the dividend or discount credited to
the account of the subscribers would not constitute interest. He also held
that the CBDT circulars are not binding on the appellate authorities.

Aggrieved by the orders of CIT(A), Revenue preferred an
appeal to the Tribunal.

Held :

The Tribunal noted that the scheme of Chit Funds is
regulated by The Chit Funds Act, 1982 and S. 3 in Chapter I of the Chit Funds
Act provides that the provisions of the Act override all other laws,
memoranda, articles, etc. save as otherwise expressly provided in the Act. In
view of the non obstante clause the Tribunal held that the definitions of the
expression ‘discounts’, ‘dividends’, ‘prize amount’ as given in the said Chit
Funds Act will prevail over similar definition as found in the Income-tax Act.
The Tribunal held that in a scheme of chit fund there is neither any money
borrowed nor a debt incurred and since interest is defined in the Income-tax
Act as interest payable in any manner in respect of any monies borrowed or
debt incurred (including deposit) and in a chit fund there is neither any
money borrowed nor a debt incurred, the dividends paid by the foreman to the
subscribers of the chit cannot be said to be answering the definition of
interest. The Tribunal held that the demands created u/s.201(1) and
u/s.201(1A) were not justified. It upheld the order of the CIT(A) and
dismissed the appeals filed by the revenue.

levitra

Nirav Shah

Income-tax Act, 1961 — S. 40(a)(ia) and S. 194C — Whether an agreement entered into by the assessee with distributors whereby revenue was shared was a works contract and therefore liable to TDS u/s.194C — Held, No.

New Page 1

2009 TIOL 273 ITAT (Del.)

Competent Films Pvt. Ltd. v. ITO

ITA No. 3397/Del./2008

A.Y. : 2005-2006. Dated : 9-2-2009

Income-tax Act, 1961 — S. 40(a)(ia) and S. 194C — Whether
an agreement entered into by the assessee with distributors whereby revenue
was shared was a works contract and therefore liable to TDS u/s.194C — Held,
No.

Facts :

The assessee company was engaged in the business of running
of cinema hall, canteen and food courts. It had entered into a Memorandum of
Understanding (MOU) with M/s. Mukta Movies Distributors (Distributors) which
inter alia provided that — the assessee was to be a booking agent for
the cinema hall for three years; the assessee had exclusive rights to book
Hindi films for the said cinema and to run a certain number of shows daily as
per the local laws; the MOU also fixed the rate of admission to the cinema
hall; stated revenue at full capacity and the amount due to the assessee on a
weekly basis subject to the exceptions provided in the MOU.

The distributor raised a bill on the assessee under which
the daily collections were shown and after reducing the payment to be made to
the assessee for the cinema hall hired, a bill was raised for the balance by
the Distributor which bills were paid by the assessee. The Assessing Officer
(AO) held that the MOU was in the nature of a works contract and held the
assessee liable to deduct tax at source u/s.194C. Since the assessee had not
deducted tax on payments made to distributor pursuant to the said MOU, the AO
disallowed a sum of Rs.72,43,965 by invoking provisions of S. 40(a)(ia).

The CIT(A) upheld the order of the AO. Aggrieved, assessee
preferred an appeal to the Tribunal.

Held :

The Tribunal upon a close reading of the agreement held it
to be a profit sharing agreement. It further held that the agreement was not
for services rendered but for sharing the profits with the assessee. Following
the ratio of the decisions of Ahmedabad Bench of ITAT in Sunsel
Drive-in-Cinema (P.) Ltd. v. ITO, (2006) 5 SOT 64 (Ahd.) and Mumbai Bench
of ITAT in ITO v. Shrinagar Cinemas (P.) Ltd., (2008) 20 SOT 480 (Mum.)
it held that there was no works contract and, therefore, the assessee was not
liable to deduct any tax u/s.194C of the Act. The Tribunal found that the
distributor has only given the right to exhibit the films and the assessee had
only rendered the services of exhibiting the films and therefore the question
of deduction of tax by the assessee did not arise. The claim of the assessee
was allowed.

levitra

Nirav Shah

Income-tax Act, 1961 — S. 158BFA — Whether for levy of penalty u/s.158BFA issuance of notice is mandatory — Held, Yes. Whether in the absence of issuance of pre-requisite notice, the entire penalty proceedings are to be held as illegal and without jurisdi

New Page 1

2009 TIOL 300 ITAT Bang.

ITO v. H. E. Distillery Pvt. Ltd.

IT(SS)A No. 28 (Bang.)/2008

Block Period : 1-4-1990 to 18-1-2001 Dated : 30-1-2009

Income-tax Act, 1961 — S. 158BFA — Whether for levy of
penalty u/s.158BFA issuance of notice is mandatory — Held, Yes. Whether in the
absence of issuance of pre-requisite notice, the entire penalty proceedings
are to be held as illegal and without jurisdiction — Held, Yes.

Facts :

The assessee, in response to notice u/s158BC, filed return
for block period on 13-8-2001 admitting undisclosed income of Rs.73,80,526.
The AO assessed the undisclosed income at Rs.2,42,47,658 and initiated
proceedings for levy of penalty u/s.158BFA(2) on the ground that the assessee
failed to disclose the income and furnished inaccurate particulars of income.
Against the order assessing undisclosed income the assessee filed an appeal on
the ground that business loss suffered by the assessee during the block period
and depreciation have to be set off against undisclosed income. The CIT(A) and
the Tribunal decided the appeal against the assessee.

The assessee vide letter dated 15-12-2005 was asked to
offer explanation to the proposed penalty. No reply was received from the
assessee. The AO levied a minimum penalty of Rs.1,18,40,726.

The assessee filed an appeal to the CIT(A) and challenged
levy of penalty on the ground that no notice for initiation of penalty was
issued. The CIT(A) cancelled the penalty.

Aggrieved, the revenue preferred an appeal to the Tribunal
where on behalf of the Revenue it was inter alia contended that the assessment
order did mention that penalty proceedings u/s.158BFA(2) are initiated; the
assessee attended the proceedings for levy of penalty; during the penalty
proceedings when the AO was transferred the new AO did issue a notice before
imposing penalty. It was submitted that CIT(A) took a rigid and narrow view
that physical service of notice was a must before imposition of penalty for
concealment. The intention of the AO to levy penalty was never in doubt.

Held :

The Tribunal relying on the decision of the Supreme Court
in the case of 82 ITR 821, 61 ITR 147, 76 ITR 696, 168 ITR 705 and also on the
decision of the co-ordinate bench of the Tribunal in IT(SS)A. No.
21/Bang./2001 in the case of Nemichand held that issuance of notice is a
pre-requisite for assuming jurisdiction to levy penalty u/s.158BFA(2) and in
the absence of issuance of a pre-requisite notice, the entire penalty
proceedings were held to be illegal and without jurisdiction. It held that
CIT(A) was perfectly justified in canceling the penalty. The Tribunal
confirmed the order of CIT(A) and dismissed the appeal filed by the revenue.

levitra

Nirav Shah

Income-tax Act, 1961 — S. 36(1)(v), S. 40A(7) and S. 263 — Whether it is necessary for CIT to make further inquiries before cancelling the assessment order of the AO — Held, No. Whether the CIT can regard an order as erroneous on the ground that the AO sh

New Page 1

2009 TIOL 317 ITAT (Mad.) SB

Rajalakshmi Mills Ltd.
v. ITO

ITA No. 1074/Mds./1987

A.Y. : 1981-82. Dated : 24-4-2009

Income-tax Act, 1961 — S. 36(1)(v), S. 40A(7) and S. 263 —
Whether it is necessary for CIT to make further inquiries before cancelling
the assessment order of the AO — Held, No. Whether the CIT can regard an order
as erroneous on the ground that the AO should have made further inquiries
before accepting the statements made by the assessee in his return — Held,
Yes. Whether the word ‘erroneous’ in S. 263 includes cases where there has
been failure to make the necessary inquiries — Held, Yes. Whether it is
incumbent on the AO to investigate the facts stated in the return when
circumstances would make such an inquiry prudent and the word ‘erroneous’ in
S. 263 includes cases where there has been failure to make such an enquiry —
Held, Yes. Whether it is correct to say that the provision made by the
assessee in the accounts for the purposes of making contributions to approved
gratuity fund should be allowed despite the fact that there was no incremental
liability towards the gratuity due for the assessment year under consideration
— Held, No.

Facts :

For the A.Y. 1981-82 the balance sheet of the assessee
company reflected provision for gratuity at Rs.7,85,600 which sum was claimed
by the assessee, in its return of income, u/s.36(1)(v). The AO allowed the
same without making any discussion in the assessment order. The Commissioner
of Income-tax (CIT) assumed jurisdiction u/s.263 as in his opinion the order
was erroneous and prejudicial to the interest of the revenue.

The CIT found that the approved (sic actuarial) gratuity
liability as on 31-3-1981 and 31-3-1980 was Rs.55,35,469 and Rs.51,974,80
respectively. Hence, the amount payable as contribution to the fund was
Rs.3,37,989. The AO had allowed Rs.7,85,600. Accordingly, the CIT by relying
on the decision of the Apex Court in the case of Shree Sajjan Mills Ltd. (156
ITR 585) directed the AO to withdraw the excess allowance of Rs.4,47,611.

In an appeal to the Tribunal the assessee contended that
the conditions precedent for invoking S. 263 have not been satisfied and also
that it is entitled to claim deduction of Rs.7,85,600 being provision for
gratuity actually paid to an approved gratuity fund.

The President of the ITAT constituted a Special Bench to
consider the following questions :

(1) Whether the CIT was correct in invoking the
provisions of S. 263 and in withdrawing the claim of deduction of
Rs.7,85,600, allowed by the AO, being the amount actually paid to an
approved gratuity fund and in allowing incremental actuarial liability
worked out at Rs.3,37,989 ?

(2) Whether the assessee was entitled to claim deduction
of Rs.7,85,600 being the provision of gratuity in terms of S. 36(1)(v) of
the Act, actually paid to an approved gratuity fund on the facts and in the
circumstances of the case ?

(3) Whether the Appellate Tribunal’s order dated
21-6-1990 in ITA No. 529(Mds.)/87 rendered in the assessee’s own case for
A.Y. 1982-83 could be said to be an order rendered per incuriam and not
binding in view of non-consideration of correct legal position in this
regard ?

Held :

The Special Bench (SB) found that the AO had not made any
inquiries regarding the allowability of the sum of Rs.7,85,600 claimed by the
assessee as provision for gratuity actually paid to an approved gratuity fund.
The SB after considering the ratio of the decision of the Apex Court in the
case of Rampyari Devi Saraogi v. CIT, (67 ITR 84) (SC) held as under :

“It is not necessary for the CIT to make further
enquiries before cancelling the assessment orders of the AO. The CIT can
regard the order as erroneous on the ground that in the circumstances of the
case the AO should have made further inquiries before accepting the
statements made by the assessee in his return. The reason is obvious. Unlike
a Civil Court which is neutral in giving a decision on the basis of evidence
produced before it, an AO is not only an adjudicator but also an
investigator. He cannot remain passive in the face of a return which is
apparently in order but calls for further enquiry. It is the duty of the AO
to ascertain the truth of the facts stated in the return when the
circumstances of the case are such as to provoke inquiry. The meaning to be
given to the word ‘erroneous’ emerges out of this context. The word
erroneous would include cases where there has been failure to make the
necessary inquiries. It is incumbent on the AO to investigate the facts
stated in the return when the circumstances would make such an inquiry
prudent and the word ‘erroneous’ in S. 263 includes the failure to make such
an enquiry. The order becomes erroneous because such an enquiry has not been
made and not because there is anything wrong with the order if all the facts
stated therein are assumed to be correct.”

Accordingly, it held that the order passed by AO was
erroneous and prejudicial to the interest of the revenue and that the
conditions precedent for exercising jurisdiction u/s.263 did exist in the
facts of the present case.

As regards the contention of the assessee that since the
provision was made by the assessee for the purpose of payment of a sum by way
of contribution towards the approved gratuity fund, the amount of provision
should be allowed within the meaning of S. 40A(7)(b), the SB following the
ratio of the decision of Madras High Court in CIT v. Loyal Textile Ltd.,
(231 ITR 573) held that it would be incorrect to say that provision made by
the assessee in the accounts for the purposes of making contributions to
approved gratuity fund should be allowed u/s.40A(7)(b)(i) despite the fact
that there was no incremental liability towards the gratuity due for the
assessment year under consideration. It held that an expenditure which is
deductible for income-tax purposes is towards a liability actually existing at
the time, but setting apart money which might become expenditure on the
happening of an event is not expenditure allowable under the law. Since the
assessee did not place anything to demonstrate the nature of liability nor was
there any material to come to a conclusion that the liability was an
ascertained liability the contention of the assessee was rejected.

Nirav Shah

No contract between assessee transporter and agents/suppliers who enabled the assessee to get the truck hired, but with truck owners and drivers — Deduction of tax u/s.194C not applicable

New Page 2

38 Assessee engaged in Transportation of
goods — No contract between assessee and the agents/suppliers who enabled the
assessee get the truck hired, but with the truck owners and drivers — Deduction
of tax u/s.194C — Held, Not applicable.

Facts :

The assessee company is engaged in the business of
transportation of goods for various clients all over India on a contract basis.
The AO, subsequent to survey action u/s.133A, concluded that the appellant had
not deducted taxes properly on payments made to truck owners or agents in
accordance with the provisions of S. 194C. The assessee had made total payments
of Rs.17,08,39,119 to various parties whose trucks were engaged. The AO
estimated an ad hoc 90% of the total payment as payment exceeding
Rs.20,000 and computed tax liability thereon @ 1% + 2% surcharge. Further, he
also levied interest u/s.201(1A). The CIT(A) deleted the demand raised by the
AO, stating that the provisions of S. 194C were not applicable.

On appeal to the Tribunal, it was held that :

1. From various correspondences and confirmations, it is
clear that the suppliers/agents were contacted for reference purposes only and
the negotiations for a particular destination were made with the truck
drivers/owners and not with the suppliers/agents.

2. Further, no contracts were entered into between the
assessee and agent/supplier, but were entered into with the truck
owners/drivers. In addition, no payments exceeding Rs.20,000 were made to
truck owners/drivers and where the payment so exceeded, tax has been
appropriately deducted at source and deposited into the treasury.

3. Further, Circular 715 issued by the CBDT was squarely
applicable to the facts and thus, it was clear that if the contracts are with
the truck owners/drivers and GR is separate, then the payment made for the
truck has to be a separate payment. Consequently, it cannot be said that there
was contract with the suppliers and not with the truck owners/drivers. Hence,
the CIT(A) was held right in stating that the provisions of S. 194C were not
applicable.

Case referred to :

City Transport Corporation v. ITO, [(2007) 13 SOT 479 (Mum.)]

levitra

Nirav Shah

Concept of ‘Real Income’ — Assessee-company did not recognise interest income on debentures due to financial difficulties of issues — No interest income accrued to the assessee.

New Page 2

37 (2008) 300 ITR (AT) 159 (Delhi)

Pranav Vikas (India) Ltd. v.
ACIT

ITA No. 3322/Del./2004 (A.Y. 2001-02)

A.Y. 2001-02. Dated : 27-7-2007

Concept of ‘Real Income’ — Investment in debentures —
Assessee-company decided not to recognise interest income on debentures due to
financial difficulties of M/s. PAL Enterprise (P) Ltd. — Held that, No interest
income accrued to the assessee.

Facts :

The assessee-company had received interest free advance of
Rs.20 lakhs from M/s. Premier Automobiles Ltd. (PAL) for development of certain
products and since the said project was being delayed considerably, M/s. PAL
required the assessee to invest the said amount in their other group company
i.e., M/s. PAL Enterprise (P) Ltd. (PALEL) by way of 13% unsecured
optionally convertible debentures. For the F.Y. 2000-01, the assessee company
did not recognise the revenue arising out of interest on debenture, because both
M/s. PAL as well as M/s. PALEL became sick and there was no possibility of
recovery of any interest on the debenture. The AO made an addition of
Rs.2,40,000 disregarding AS-9 issued by ICAI, which was mandatory u/s.211(3C) of
the Companies Act, 1956 for the assessee company and the minutes of the BOD
acknowledging the uncertainty of collection of the said interest and the same
was also confirmed by the CIT(A).

On appeal to the Tribunal, it was held that :

1. The request of M/s. PALEL to treat the investment made
by the assessee-company as interest-free was accepted by it insofar as the
year under consideration is concerned and the right to receive interest income
on the said debentures, thus, was waived by it with prospective effect. The
decision to take the ‘appropriate measures’ as discussed in the meeting of the
BOD is to be understood to be restricted to the recovery of principal amount
and the interest accrued thereon for the earlier years.

2. Further, even if a decision of waiver is taken after the
F.Y., but within a reasonable proximity such that it results into a formal
resolution, it cannot be said that the said decision is inapplicable to the
relevant F.Y.

3. In the instant case, as the right to receive interest
income on the said debentures was waived by the assessee company for the year
under consideration, there was no real income that can be bought to tax in the
hands of the assessee company on accrual basis. Hence, the impugned order of
the CIT(A) was set aside deleting the addition of Rs.2,40,000.

Cases referred to :

(i) CCE v. Dai Ichi Karkaria Ltd., [(1995) 156 CTR
172];

(ii) Ashokbhai Chimanbhai [(1956) 56 ITR 42];

(iii) CIT v. Shoorji Vallabhdas and Co., [(1962) 46
ITR 144];

(iv) State Bank of Travancore v. CIT, [(1986) 158
ITR 102] and others.

(2008) 300 ITR (AT) 193 (Mumbai)

ITO v. Bhoruka Roadlines Ltd.

A.Y. 2002–03. Dated : 27-6-2007

S. 194C, S. 201 and S. 201(1A)

levitra

Nirav Shah

Sum received under non-compete agreement — Capital receipt.

New Page 2

36 (2008) 300 ITR (AT) 113 (Delhi) (SB)

Saurabh Srivastava v. DCIT

ITA No. 3014 (Delhi) 2004

A.Y. 1998-99. Dated : 7-12-2007

S. 17(2)(v); S. 17(3)(i) and S. 28(ii)

Sum received under non-compete agreement — Held, that it is
capital receipt.

Facts :

The assessee, a computer engineer associated with software
and information technology, was the promoter, founder and the managing director
of a software company holding 866,450 shares therein. The company was taken over
by a U.K. group whereby 76% of the subscribed equity capital was agreed to be
transferred in favour of the U.K. company. In addition to share transfer
agreement, the U.K. group also entered into a non-compete agreement with the
assessee, whereby the assessee received a sum of Rs.1,07,36,570 as non-compete
fee for F.Y. 1997-98. Thereafter, under a new service agreement, the assessee
was employed as the managing director of the U.K. company and received salary
accordingly. The assessee claimed exemption of non-compete fees as being a
capital receipt.

The AO taxed the non-compete fee as revenue receipt
u/s.28(ii). The CIT(A) upheld the order of AO.

On appeal to ITAT, the Hon’ble Tribunal held that the said
non-compete fee is a capital receipt, not liable to tax and referred to the
following :

1. The non-compete agreement was independent, distinct and
separate from the service agreement.

2. It was not dependent on his continuing in employment
with the company.

3. It did not arise from employer-employee relationship.

4. The fee was received for accepting restrictive
covenants, as the assessee was restrained from carrying out any software
development activity for any other person who directly or indirectly competed
with the U.K. group.

5. Thus, the same was not taxable u/s.17.1

6. The assessee was not carrying on any business and the
non-compete fee did not arise in the course of business and hence was not
taxable as business income.

7. The same was also not liable to tax as capital gains or
as income from other sources.

Cases referred to :

(i) CIT v. Saroj Kumar Poddar, [(2005) 279 ITR 573
(Cal.)];

(ii) CIT v. A. S. Wardekar, [(2006) 283 ITR 432
(Cal.)];

(iii) Swamy (R.K.) v. Asst. CIT, [(2004) 88 ITD 185
(Chennai)] and others.

1 Clause (iii) of Ss.(3) of S. 17 was inserted w.e.f. the
Finance Act, 2001 and not with retrospective effect and hence was not
applicable for A.Y. 1998-99. However, the said amount, if received subsequent
to the introduction of the said sub-section may stand on a different footing
as compared to that, in the case discussed.

levitra

Nirav Shah

S. 234B read with S. 208 & S. 209 : Assessee having only salary income not liable to pay advance tax.

New Page 2

35 (2008) 21 SOT 549 (Delhi)

Asst. Director of Income-tax, International Taxation
v. Western Geco International Ltd.

ITA Nos. 4847 to 4941 (Delhi) of 2007

A.Y. 2006-07. Dated : 21-2-2008

S. 234B read with S. 208 and S. 209 of the Income-tax Act,
1961 — There is no question of payment of advance tax by an employee whose total
income comprises of salary from which tax at source is to be deducted as per
statutory provisions and, hence, there is no question of applying provisions of
S. 234B to such a person who is not liable to pay advance tax.

Company ‘G’ was agent of many foreign nationals. It paid
salary to different non-resident assessees and filed returns on their behalf.
The assessees/employees only had salary income, which was subjected to deduction
of tax at source. They claimed deduction u/s.10(10CC) on account of tax paid by
the employer on their salary as per agreement. The Assessing Officer refused to
allow the said deduction and added tax paid on income through multiple grossing
instead of single grossing. This led to additional liability and demand
representing the difference between the assessed tax and tax deducted at source
leading to levy of interest u/s.234B for non-payment of advance tax. On appeal,
the CIT(A) held that the Assessing Officer was not right in levying interest
u/s.234B upon the assessees and, accordingly, deleted the same.

The Tribunal, following the decision in the case of
Motorola Inc. v. Dy. CIT, (2005) 95 ITD 269 (Delhi) (SB) held that the
assessees were not liable to pay advance tax, and consequently, were also not
liable to pay any interest u/s.234B. The Tribunal noted as under :

(1) Clause (d) of S. 209(1) clearly provides that while
computing advance tax, the amount of income-tax which is deductible or
collectible at source, will be deducted from the advance tax payable. In other
words, advance tax payable will be reduced by the amount of tax at source
‘deductible or collectible’.

(2) Therefore, when tax is deductible or collectible at
source from salary, which is the only source of income, no advance tax would
be payable by such an employee.

(3) In the instant case, there was no dispute that total
income of the assessee was subjected to deduction of tax at source u/s.192.
The assessee had no amount of advance tax payable if tax at source deductible
from the assessee’s salary was taken into account.

(4) Advance tax is payable in the financial year on the
current income. It cannot be paid after the close of the year. However, a
salaried person, whose salary is subject to deduction of tax at source, cannot
come to know of any short recovery or no recovery of tax at source till the
close of the financial year in which tax is deductible. If the employer has
not correctly deducted tax at source from the salary in one month u/s.192, the
deficiency can be made good U/ss.(3) of S. 192. Therefore, the employer can
always make good the deficiency in deduction of tax at source within the
financial year. If in one month there is short deduction of tax at source, the
employer can make higher deduction in other months in the financial year and
make good the short deduction.

(5) Therefore, a salaried employee would not know that
there had been short, wrong or no deduction of tax at source unless the
financial year is over. By the time he would come to know about short recovery
or no recovery of tax at source in his case, the time for payment of advance
tax would be over. In case of short recovery the employer is liable to pay
interest and penalty and not the employee. That is the scheme of the Act.

(6) Therefore, there is no question of payment of advance
tax by an employee whose total income comprises of salary from which tax at
source is to be deducted as per statutory provisions. Further, there is no
question of applying provisions of S. 234B to such a person who is not liable
to pay advance tax.

levitra

Nirav Shah

S. 115JB : Capital receipts which do not constitute income, cannot be brought to tax by S. 115JB.

New Page 2

34 (2008) 21 SOT 79 (Mum.)

ITO v. Su-raj Jewellery (India) Ltd.

ITA Nos. 8800 and 8801 (Mum.) of 2004

A.Ys. 1997-98 and 2001-02.

Dated : 10-10-2007

S. 115JB of the Income-tax Act, 1961 — Capital receipts which
do not constitute income under the Act cannot be brought to tax by employing
mechanism of S. 115JB.

For A.Y. 2001-02, the assessee credited certain capital
receipts to its profit & loss appropriation account and claimed that such
capital receipts did not form part of its book profits for the purpose of MAT
profit u/s.115J since they were not liable to tax. The Assessing Officer
rejected the claim of the assessee and included these sums in book profits for
the purpose of calculating MAT. The CIT(A), however, upheld the assessee’s
claim.

The Tribunal also allowed the assessee’s claim. The Tribunal
noted as under :

(1) The intention of bringing S. 115JB on the statute was
that companies should be made to pay taxes on the basis of the net profits
shown in their profit and loss account. For the purpose of computing the MAT
profit u/s.115JB, business profits as declared in the profit and loss account
are to be considered by the Assessing Officer after making certain
adjustments.

(2) In this case, the assessee was not liable to pay any
tax on the capital receipt i.e., gain arising on transfer of its assets
to holding company. Such profit was exempt from tax u/s.47(v).

(3) Although for computing the MAT profit u/s.115JB,
business profits shown in the profit and loss account are to be adopted, in
case the said profits include certain receipts which are not in the nature of
income, the same are to be excluded before making any calculations in that
regard.

(4) Further, S. 349 of the Companies Act clearly provides
that credit for the profit arising on sale of any immovable property or fixed
assets of capital nature should not be taken into profit and loss account and,
accordingly, the profits/ gains arising on transfer of assets to the holding
company were not includible in the profits of the assessee-company.

(5) The CIT(A) had rightly held that capital receipts which
do not constitute income under the Act cannot be brought under the tax net by
employing the mechanism of S. 115JB and the said Section has not intended to
bring all non-income items within the domain of the Act.

levitra

Nirav Shah

S. 14A : Interest paid on funds invested in shares which yielded no dividend income cannot be disallowed.

New Page 2

33 (2008) 21 SOT 42 (Mum.) (SMC)

Shree Shyamkamal Finance & Leasing Co. (P) Ltd. v.
ITO

ITA No. 15 (Mum.) of 2006

A.Y. 2002-03. Dated : 15-10-2007

S. 14A of the Income-tax Act, 1961 — Interest paid on funds
invested in shares which have yielded no dividend income cannot be disallowed
u/s.14A.

During the relevant assessment year, the assessee-company
which was engaged in the business of finance and investment in equity shares,
acquired unquoted equity shares of its subsidiary company out of unsecured loan
taken. The interest paid on the loan was claimed as deductible expenditure. The
Assessing Officer required the assessee to explain as to when there was no
income from investment and if any income accrued at all as dividend which was
exempt from tax u/s.10(33), then why should not the disallowance of interest on
loan be made u/s.14A. The assessee’s contention that since it had not received
any dividend and, further, since it had not claimed any exemption of income, S.
14A could not be applied was not accepted by the Assessing Officer and he
disallowed the interest expense u/s.14A. The CIT(A) upheld the disallowance.

The Tribunal, relying on the decision in the case of Jt.
CIT v. Holland Equipment Co. B. V., (2005) 3 SOT 810, held that no
disallowance could be made u/s.14A.

The Tribunal noted as under :

(1) By virtue of S. 10(33), as it stood at relevant time,
dividend income referred to in S. 115-O does not form part of the total
income. If the assessee earned income which is not includible in the total
income, then the expenditure could be disallowed u/s.14A, because it speaks of
expenditure incurred by the assessee in relation to income which does not form
part of the total income.

(2) A reading of S. 14A makes it clear that while computing
the income under Chapter IV, deduction would not be allowed with regard to
expenditure incurred by the assessee in relation to an income which does not
form part of the total income under the Act.

(3) In the instant case, there was no dividend income
earned by the assessee. Therefore, there was no income which could be termed
as ‘income which does not form part of the total income under the Act’.
Therefore, the provisions of S. 14A were not applicable.

levitra

Nirav Shah

S. 28(iv) : Gift received by assessee in return for helping the donor on various occasions was not income

New Page 2

32 (2007) 18 SOT 362 (Delhi)

ITO v. Sunil Mittal

ITA No. 4350 (Delhi) of 2004

A.Y. 2001-02. Dated : 28-9-2007

S. 28(iv) of the Income-tax Act, 1961 — Gift received in
return for help rendered to a person on various occasions is not income within
the meaning of S. 28(iv).

During the year, the assessee received a gift of Rs.6 lacs
from a person whom he had helped on various occasions. The donor confirmed the
gift and the reason for giving the gift. The Assessing Officer, however, held
that gift was received during the course of the assessee’s business and,
accordingly, treated the same as income u/s.28(iv). The CIT(A) treated the gift
as genuine and deleted the addition made by the Assessing Officer.

The Tribunal held that the gift received by the assessee was
not income u/s.28(iv). The Tribunal observed as under :

(1) It was an accepted fact that the addition was not made
u/s.68 as unexplained cash credit. It was also accepted that the identity and
creditworthiness of the party were established and the transaction was
genuine.

(2) As per S. 28(iv), the value of any benefit or
perquisite, whether convertible into money or not, arising from the business
or the exercise of a profession, shall be treated as income chargeable to
income-tax under the head ‘Profits and gains of business or profession’.

(3) The amount was received by cheque and was not in any
intangible form in the nature of benefit or perquisite. The amount was not
received in kind. Thus, it could not be treated as benefit or perquisite.

(4) The assessee helped the donor on various occasions.
Thus, it was not in the course of carrying on the assessee’s business that any
benefit or perquisite was received.

Therefore, the gift amount was outside the scope of income in
terms of S. 28(iv).

levitra

Nirav Shah

S. 80HHC r. w. S. 147 — Assessee filed original return but did not claim deduction u/s.80HHC since no positive business income — Case reopened and certain disallowances made — Consequently business income turned positive — Assessee claimed deduction u/s.8

New Page 1

37 ITO v. Tamilnadu Minerals Ltd.
(2010) 124 ITD 156 (Chennai TM)
A.Ys. : 2001-02 & 2002-03. Dated : 13-10-2009

S. 80HHC r. w. S. 147 — Assessee filed original return but
did not claim deduction u/s.80HHC since no positive business income — Case
reopened and certain disallowances made — Consequently business income turned
positive — Assessee claimed deduction u/s.80HHC — AO did not allow the claim
since it was not claimed in the original return and no tax audit report was
filed. Held—Assessee rightfully claimed deduction.

Facts :

The assessee company is a Government of Tamil Nadu
undertaking engaged in the manufacture and export of granites. During the year
under consideration, the total income declared by the assessee was
Rs.2,97,86,549. This total income constituted entirely of income from other
sources. There was no positive income under the head ‘business income’.
Subsequently the assessment was reopened u/s.147 and the AO made certain
disallowance u/s.43B and u/s.14A. This resulted into positive business income.
The assessee thus contended that it should be allowed deduction u/s. 80HHC. The
Assessing Officer rejected the plea on the ground that the deduction was not
claimed in the original return despite there being a positive income, the
assessee had also not filed the audit report and the proceedings u/s.147 are for
the benefit of the revenue and so the assessee cannot claim a benefit which it
had not claimed in the original return.

Held :

(i) S. 147 being for the benefit of the revenue, the
assessee cannot be permitted to convert the reassessment proceedings into an
appeal or revision in disguise, and seek relief in respect of items not
claimed into the original assessment proceedings. However, in the given case,
the assessee could not have claimed the deduction in absence of any business
profits. Further, no sooner the disallowance u/s.43B was proposed by the AO,
the assessee immediately put forth its claim for deduction u/s.80HHC. This it
did because as a result of disallowance, the business income turned positive.
The assessee thus claimed a rightful deduction.

(ii) The argument of the Revenue that the assessee could
have filed a revised return has no force.

(iii) In original return since the deduction was not
claimed, there was no question of filing the audit report as well. But when
the business income became positive and when the assessee made a claim for the
deduction, it is well within its right to file the audit report at the time of
making the claim.

Nirav Shah

S. 194C(2) — Assessee hired lorries from other tank lorry owners to carry out the activity of transportation — Whether payments made to the tank lorry owners would amount to sub-contract within the meaning of S. 194C(2) — Held, No.

New Page 1

36 Mythri Transport Corporation v. ACIT
(2010) 124 ITD 40 (Visakhapatnam)
A.Y. : 2005-06. Dated : 9-1-2009

S. 194C(2) — Assessee hired lorries from other tank lorry
owners to carry out the activity of transportation — Whether payments made to
the tank lorry owners would amount to sub-contract within the meaning of S.
194C(2) — Held, No.

Facts :

The assessee was a transport contractor engaged in
transporting bitumen to various points. Since the assessee did not have enough
number of lorries, it hired lorries from others. The tank lorry owners from whom
the lorries were hired were paid amounts after the receipt of bills from the
contractees by the assessee after retaining a certain amount termed as
commission.

The Assessing Officer and the CIT(A) held that the tank lorry
owners were sub-contractors and any payment made to tank lorry owners would come
within the purview of S. 194C.

Held :

As per the provisions of S. 194C(2), the sub-contractor
should carry out whole or any part of the work undertaken by the assessee. It
signifies positive involvement in the execution of the whole or any part of the
main work by spending his time, money and energy. In the instant case, there is
no material to suggest that the other lorry owners involved themselves by
spending their time, money and energy or by taking risk associated with the main
contract work. Hence, the payment made to the lorry owners would not fall within
the purview of S. 194C(2).

levitra

Nirav Shah

S. 271(1)(c) — Mere change of head of income by AO cannot be construed as concealment of income — Valuation made by DVO cannot be construed as basis for levying penalty — Valuation done by DVO can be adopted by AO only when there is material on record tha

New Page 1

35 DCIT v. JMD Advisors (P) Ltd.
(2010) 124 ITD 223 (Delhi)
A.Y. : 2003-04. Dated : 8-2-2008

S. 271(1)(c) — Mere change of head of income by AO cannot be
construed as concealment of income — Valuation made by DVO cannot be construed
as basis for levying penalty — Valuation done by DVO can be adopted by AO only
when there is material on record that sale consideration received by assessee is
more than that declared by him.

Facts :

The assessee-company was engaged in the business of real
estate. It purchased a property and carried on construction work on the same.
The constructed building alongwith the land was then sold at a loss. This loss
was claimed as business loss by the company. The Assessing Officer observed that
the said property was shown in the balance sheet as ‘fixed assets’ and not as
stock in trade. He thus held that the loss incurred was a long-term capital loss
and not business loss. He further referred the matter to the DVO to estimate the
sale consideration and the cost of construction of the property. Based on the
valuation figures given by the DVO, the AO worked out figure of long-term
capital loss.

He also initiated penalty proceedings u/s.271(1)(c) of the
Act.

Held :

(a) The Assessing Officer ignored the fact that the
assessee-company was incorporated with the main object of carrying on real
estate business. Further, the assessee had shown the property as ‘work in
progress’ in the balance sheets of prior years. Hence the action of the AO to
treat the property as capital asset was not well founded.

(b) Even though the action of the AO was not challenged in
the quantum proceedings as the income assessed was finally a loss, this cannot
draw any adverse inference in the penalty proceedings. Also, a mere change in
the head of income cannot be construed as concealment of income.

(c) Further, for reference to the DVO for valuation of the
fair market value, the AO first needs to bring the material on record to prove
that the assessee has received more consideration than that declared by him.
Since there was no material on record, the action of AO was not tenable in law
and addition made on this basis cannot be treated as concealed income of the
assessee to attract penalty.

(d) The AO had further substituted the cost of construction
recorded in the books of the assessee with the valuation of DVO. However, no
material was brought on record by the AO that the cost of construction was an
inflated one in the books of account of the assessee. Hence, the addition made
by the AO by substituting the cost of construction by the valuation of DVO was
not justified, much less the imposition of penalty.

levitra

Nirav Shah

S. 55A—Bearing in mind that in the 1980s, it was common practice to pay a part of sale consideration by unaccounted cash, the rates given by independent media and press like Times of India/Accommodation Times is certainly more reliable indicator of the pr

New Page 1

34 2010 TIOL 277 ITAT (Mum.)
Kumar K. Chhabria v.
ITO
A.Y. : 2005-06. Dated : 30-3-2010

S. 55A—Bearing in mind that in the 1980s, it was common
practice to pay a part of sale consideration by unaccounted cash, the rates
given by independent media and press like Times of India/Accommodation Times is
certainly more reliable indicator of the prevailing market value of properties
than comparable sale instances.

Facts :

The assessee, while computing long-term capital gain arising
on transfer of office premises purchased by him for Rs.69,000 on 1st October,
1978, considered the fair market value of this property as on 1st April, 1981 to
be its cost of acquisition. The fair market value claimed to be Rs.16,20,000 was
backed by a valuation report by an approved valuer which report relied upon
certain press reports about prevailing market prices and not on any comparable
sale instances.

The Assessing Officer (AO) found the value as per comparable
sale instances in the same society to be much lower. The assessee on being
confronted with these instances submitted that these transactions apparently had
cash element in the consideration and that the valuation of the assessee was
also in consonance with Indian Valuer Directory and Reference Book. The AO
referred the matter to the DVO who valued the premises at Rs.3,00,000 on the
basis of certain sale transactions at Cuffe Parade area. The AO adopted this
amount of Rs.3,00,000 as fair market value of the property on 1-4-1981 and
computed long-term capital gains on that basis. He rejected the assessee’s
objection to the DVO report by stating that this report is binding on the AO.

Aggrieved the assessee preferred an appeal to the CIT(A) who
rejected the appeal of the assessee.

Aggrieved the assessee preferred an appeal to the Tribunal.

Held :

(i) A Third Member decision of the Tribunal in the case of
Rubab M. Kazerani v. JCIT, 91 ITD 429 (TM) has concluded that reference to DVO
u/s.55A can be made when value of the property as disclosed by the assessee is
less than the fair market value and not vice-versa. In the present case, on
the contrary, AO was of the prima facie view that the fair market value is
less than the value disclosed by the assessee. Thus, the learned CIT(A)’s
emphasis on binding nature of DVO valuation is wholly devoid of legally
sustainable basis.

(ii) It is not even in dispute that at least in eighties,
it was a common practice to pay a part of sale consideration by unaccounted
cash and it was because of this practice several legislative measures had to
be taken to combat tax evasion in property sale transactions. Bearing this in
mind, the rates given by independent media and press like Times of India/Accomodation
Times is certainly more reliable indicator of the prevailing market value of
properties. The market prices given in ‘Indian Valuer Directory & Reference
Book’, also partly supports the valuation by valuation report as filed by the
assessee.

(iii) The Tribunal noted that as against the assessee’s
valuation @ Rs.2,700 per sq.ft., the Directory & Reference Book states the
value of office premises in Nariman Point area @ Rs.2000 per sq.ft. The
valuation as per ‘Accommodation Times’, ranges from Rs.2,400 per sq.ft. to
Rs.3,200 per sq.ft. for commercial area.

(iv) The Tribunal adopted the rate of Rs.2,000 per sq.ft.
as given in the refrencer as against the valuation @ Rs.500 per sq.ft, adopted
by D.V.O. and valuation @ Rs.2,700 per sq.ft. as adopted by the assessee’s
valuer.

levitra

Nirav Shah

S. 133(6)—Merely for want of Permanent Account Numbers, the AO is not justified in disbelieving the transactions by doubting the creditworthiness of the karigars and disallowing the payments made to karigars who have confirmed the receipt of amounts.

New Page 1

33 2010 TIOL 272 ITAT (Mum.)
ACIT v. Lakhi Games Impex Pvt. Ltd.
A.Y. : 2003-04. Dated : 29-1-2010

S. 133(6)—Merely for want of Permanent Account Numbers, the
AO is not justified in disbelieving the transactions by doubting the
creditworthiness of the karigars and disallowing the payments made to karigars
who have confirmed the receipt of amounts.

Facts :

The assessee company was engaged in the business of import of
rough diamonds, cutting and polishing and thereafter export of the same. It had
claimed a sum of Rs.22,69,75,283 as labour charges paid to karigars. In the
course of assessment proceedings, particulars of individual recipients of labour
charges were furnished. The Assessing Officer (AO) issued notices u/s.133(6) to
five parties. Notice was served to one party and the other four notices were
returned unserved by the postal authorities. No reply was received from the
party to whom the notice was served. On being confronted, the assessee filed a
confirmation in respect of the said party. The assessee company also filed
confirmations of the other four parties to whom notices were issued but were
returned unserved. Since PAN in respect of all these five parties did not exist
in the confirmations, the AO doubted the creditworthiness of the parties and the
genuineness of the transactions. He disallowed the labour charges in respect of
these five parties.

Aggrieved, the assessee preferred an appeal to the CIT(A) who
observed that this is not a case of cash credit where creditworthiness has to be
examined. He held that non-availability of PAN cannot make a transaction as
non-genuine. He allowed the appeal filed by the assessee.

Aggrieved, the Revenue preferred an appeal to the Tribunal.

Held :

The Tribunal agreed with the finding of the CIT(A) that this
is not a case of cash credit and the issue relates to the allowability of
expenditure. Since the parties have confirmed to have received the payments,
merely for want of permanent account numbers the AO was not justified in
disbelieving the transactions by doubting the creditworthiness of the karigars.

The Tribunal upheld the order of the CIT(A) and the ground
raised by the Revenue was dismissed.

levitra

Nirav Shah

Capital gains — Since sale consideration of the industrial unit has been arrived at by ‘capitalisation of profits’ and not challenged by any of the authorities below, it cannot be said that the sale of unit is an itemised sale of assets of the unit.

New Page 1

42 (2010) 38 DTR (Pune) (TM) (Trib.) 393
J. B. Electronics v. JCIT
A.Y. : 1997-98. Dated : 31-12-2009

Capital gains — Since sale consideration of the industrial
unit has been arrived at by ‘capitalisation of profits’ and not challenged by
any of the authorities below, it cannot be said that the sale of unit is an
itemised sale of assets of the unit.

Facts :

The assessee-firm sold its industrial unit to the sister
concern and surplus of Rs.3,90,75,996 arising was claimed to be exempt on the
ground that it was a slump sale of its business. The price for transfer was
arrived at by capitalisation of profits method. The weighted average of net
profits for 3 preceding years has been capitalised and the consideration is
arrived at on the basis of 5 times of such weighted average. Accordingly the
sale consideration of Rs.5,64,79,500 was fixed. Individual value of assets and
liabilities was not considered in computation of price of sale of business.

The AO noted that the assessee had got its assets revalued at
Rs.1,71,85,000 as on 31st March, 1995 on the basis of valuation report of an
independent valuer. It was thus clear that the value of assets was not more than
Rs.1,71,85,000 shortly before the date of transfer of assets. The difference
between Rs.1,71,85,000 and WDV of assets was taxed as short-term capital gain
and difference between the consideration i.e., Rs.5,64,79,500 and Rs.1,71,85,000
was taxed as long-term capital gain as goodwill u/s.55(2)(ii).

Aggrieved, the assessee carried the matter in appeal before
the CIT(A) but without any success. Not satisfied with the order of the CIT(A),
the assessee carried the matter in appeal before the Tribunal. There was a
difference of opinion between the members, and the matter was referred to the
Third Member.

Held :

None of the authorities below had any issues with genuineness
or bona fides of the valuation method adopted for sale of the unit. It has never
been the case of any of the authorities below that the consideration arrived at
was part of the sham arrangement and that inter se relationship between the
buyer and the seller has vitiated the bona fides of the sale agreement.

There is no dispute that valuation as on 1st May 1996, which
was the date of transfer of the business, for individual assets is not
available, and the valuation report relied upon by the authorities below is
dated 12th April, 1995 estimating value of the assets as on 31st March, 1995.
The value of an asset as on 1st May 1996 cannot be the same as on 31st March,
1995. The decision of CIT v. Artex Manufacturing Co., 227 ITR 260 (SC), which
has been relied upon by the lower authorities will be relevant only in a case in
which sale consideration of the business is computed on the basis of values of
specific assets and liabilities.

The other aspect of the matter is that the unit has been
transferred as a going concern. Even the manpower, registrations, contracts,
permissions and sanctions were to be transferred to the buyer. The unit has been
transferred to the buyer in a fully functional state along with all the
employees and all the contracts.

Regarding the argument raised that the sale transaction is a
collusive transaction between the sister concerns and the whole theory of
valuation on the basis of capitalisation of profits is an afterthought, it has
not been the case of any of the authorities below that the sale agreement is a
sham agreement or that valuation method adopted by the assessee is not bona
fide. The payments have been made in accordance with this agreement on 1st May,
1996 itself, and therefore it cannot be said that the quantification of sales
consideration was an afterthought. As for the assessee and the buyer being
sister concerns, merely because an agreement is entered into by related parties
the effect of the agreement cannot be ignored. Therefore, the impugned
transaction is not a case of itemised sale and it is clearly a case of slump
sale of the business.

levitra

Nirav Shah

S. 80HH and S. 80-I — New industrial undertaking vis-à-vis expansion of production capacity of existing unit.

New Page 1

41 (2010) 38 DTR (Delhi) (SB) (Trib.) 137
JCIT v. Thirani Chemicals Ltd.
A.Y. : 1992-93. Dated : 9-4-2010

S. 80HH and S. 80-I — New industrial undertaking vis-à-vis
expansion of production capacity of existing unit.

Facts :

The assessee is engaged in the business of manufacturing
calcium carbonate since 1978 with a starting production capacity of 5,000 MT
annually, which was enhanced in various stages — to 7,500 MT in 1986-97 — to
9,600 MT in the year 1988-89 — to 11,000 MT in 1990-91 and 70,000 MT in 1991-92,
which resulted in corresponding increase in the production. The assessee claimed
deductions u/s.80HH and u/s.80-I in these years on the basis that with each
expansion a new industrial undertaking came into existence in the year in which
the production capacity was increased and the period of allowability of
deductions will increase accordingly.

For A.Y. 1991-92 and 1992-93, the AO rejected such claims of
the assessee holding that it was a case of gradual expansion and reconstruction
of existing unit and the increase in the production capacity cannot be held as
establishment of new industrial undertaking. The CIT(A) confirmed the view of
the AO in A.Y. 1991-92. However for A.Y. 1992-93, the CIT(A) took a different
view than his predecessor and allowed the claim of the assessee.

The Tribunal decided the appeal for A.Y. 1991-92 in favour of
the assessee relying on the observations of the CIT(A) for A.Y. 1992-93. Whereas
for A.Y. 1992-93 the Tribunal considered the matter afresh without being
influenced by the earlier order on the ground that the fact that the appeal
against the order of the CIT(A) for A.Y. 1992-93 was pending before the Tribunal
was not brought to the notice of the Tribunal at the time when the appeal for
A.Y. 1991-92 was heard. Upon considering the matter afresh, the Tribunal decided
against the assessee.

Upon further appeal to the High Court, it was directed to
form a Special Bench to resolve the controversy.

Held :

The true test is, there must emerge a new and identifiable
undertaking, separate and distinct from the existing unit. In the present case,
there is no dispute that so-called expanded new plant and machinery were
installed in the existing building, on same process line-up and infrastructure
and new equipments were connected to the old machinery set-up. The rotary gas
producer was common for the old and the new plant. Similarly, all the raw
material processed passed through a common lime holding tank. The old and the
new plant were integrated in such a manner that it was difficult to identify the
input of raw material and final product whether it was produced through the
so-called expanded plant and machinery or through the old plant and machinery.
Raw material, finished products, employees, electric connection, maintenance of
books of accounts, etc. were all common and could not be identified as coming
from new or old plant. Further, the assessee was not able to ascertain the exact
profits independently from old and expanded plant, that is why the assessee
computed its profits on proportionate basis. Therefore no independent and
distinct unit came into existence for the purpose of claiming deduction either
u/s.80HH or u/s.80-I.

levitra

Nirav Shah

S. 4 of Payment of Gratuity Act, 1972 is amended.

Part E : Miscellaneous

67 S. 4 of Payment of Gratuity Act, 1972 is
amended.

S. 4 of the Payment of Gratuity Act, 1972 is amended for increasing
the maximum amount of gratuity payable to employees from 3.5 lakh to 10 lakh.
The amendment is notified on 24th May, 2010.

levitra

Nirav Shah

The Double Tax Avoidance Treaty and Protocol signed between Finland and India on 15-1-2010.

New Page 2

Part D : COMPANY
LAW

Part E : Miscellaneous

66 The Double Tax Avoidance Treaty and Protocol
signed between Finland and India on 15-1-2010.

The Double Tax Avoidance Treaty and Protocol signed
between Finland and India on 15th January, 2010 has been notified to be entered
into force on 19th April, 2010. The treaty shall apply from 1st January, 2011
for Finland and from 1st April, 2011 for India.

levitra

Nirav Shah

Conditions of listing for issuers seeking listing on SME Exchange

New Page 2

Part D : COMPANY
LAW

65 Conditions of listing for issuers seeking listing on SME
Exchange

In recognition of the need for making finance available to
small and medium enterprises, SEBI has decided to encourage promotion of
dedicated exchanges and/or dedicated platforms of the exchanges for listing and
trading of securities issued by SMEs. Consequently, SEBI amended SEBI (ICDR)
Regulations, 2009 and specified the new ‘Model Equity Listing Agreement’ to be
executed between the SME issuer and the stock exchange.

The key highlights of the amendments to listing requirements
are :

(a) Companies listed on the SME exchange may send to their
shareholders a statement containing the salient features of all the documents,
as prescribed in sub-clause (iv) of clause

(b) of proviso to S. 219 of the Companies Act, 1956,
instead of sending a full annual report.

(b) Periodical financial results may be submitted on a
‘half-yearly basis’, instead of a ‘quarterly basis’.

(c) SMEs need not publish their financial results, as
required in the main board and can make it available on their website.

levitra

Nirav Shah

Enhancement of Disclosure Requirements in Offer Document

New Page 2

Part D : COMPANY
LAW

64 Enhancement of Disclosure Requirements in Offer Document

At the SEBI Board meeting held on 19th May 2010, it was
decided that the offer documents of companies raising capital will contain
disclosures from directors if they were directors of any company when the shares
of the said company were suspended from trading by stock exchange(s) for more
than 3 months during the last 5 years or delisted.

Visit SEBI website for a complete text of the press release
containing various decisions taken at the Board meeting.

levitra

Nirav Shah

Easy Exit Scheme, 2010

New Page 2

Part D : COMPANY
LAW

63 Easy Exit Scheme, 2010

The Ministry of Corporate Affairs vide General Circular No. 2
/2010 F. No. 2/7/2010-CL V, has on 26 May, 2010 given an opportunity to the
defunct companies, for getting their names strike off from the Register of
Companies, through an ‘Easy Exit Scheme, 2010’ u/s.560 of the Companies Act,
1956. The Scheme shall come into force on the 30th May, 2010 and shall remain in
force up to 31st August, 2010. Defunct company has been defined as a company
registered under the Companies Act, 1956, which is not carrying over any
business activity or operation on or after the 1st April, 2008 and includes a
company which has not raised its paid-up capital as provided in Ss.(3) and
Ss.(4) of S. 3 of the Companies Act, 1956.

The Scheme does not cover the following companies, namely :

(a) listed companies;

(b) companies registered u/s.25 of the Companies Act, 1956;

(c) vanishing companies;

(d) companies where inspection or investigation is ordered
and being carried out or yet to be taken up or where completed prosecutions
arising out of such inspection or investigation are pending in the Court;

(e) companies where order u/s.234 of the
Companies Act, 1956 has been issued by the Registrar and reply thereto is
pending or where prosecution if any, is

(f) pending in the Court;

(g) companies against which prosecution for a
non-compoundable offence is pending in the Court;

(h) companies which have accepted public deposits which are
either outstanding or the company is in default in repayment of the same;

(i) company having secured loan;

(j) company having management dispute;

(k) company in respect of which filing of documents have
been stayed by the Court or Company Law Board (CLB) or Central Government or
any other competent authority;

(l) company having dues towards income-tax or sales tax or
central excise or banks and financial institutions or any other Central
Government or State Government departments or authorities or any local
authorities.

Applications need to be made in the Form EES 2010, along with
affidavit and indemnity bond among other things.

levitra

Nirav Shah

Company Law Settlement Scheme, 2010

New Page 1Part D : Company
Law

62 Company Law Settlement Scheme, 2010

The Ministry of Corporate Affairs, vide the General Circular
No. 1 /2010 F. No. 2/7/2010-CL V, dated 26 May, 2010, has given an opportunity
to the defaulting companies to enable them to make their default good by filing
belated documents and to become a regular compliant in future. The Ministry, in
exercise of the powers u/s.611(2) and 637B (b) of the Companies Act, 1956 has
decided to introduce a Scheme, namely, ‘Company Law Settlement Scheme, 2010,’
condoning the delay in filing documents with the Registrar, granting immunity
from prosecution and charging additional fee of 25% of actual additional fee
payable for filing belated documents under the Companies Act, 1956 and the rules
made thereunder. The Scheme shall come into force on the 30th May, 2010 and
shall remain in force up to 31st August, 2010. The application for seeking
immunity in respect of belated documents filed under the Scheme may be made
electronically in the required Form, after closure of the Scheme and after the
document(s) are taken on file, or on record or approved by the Registrar of
Companies as the case may be, but not after the expiry of six months from the
date of closure of the Scheme.

levitra

Nirav Shah

A.P. (DIR Series) Circular No. 54, dated 26-5-2010 — Deferred Payment Protocols dated April 30, 1981 and December 23, 1985 between Government of India and erstwhile USSR.

New Page 2

Part C : RBI/FEMA

61 A.P. (DIR Series) Circular No. 54, dated 26-5-2010 —
Deferred Payment Protocols dated April 30, 1981 and December 23, 1985 between
Government of India and erstwhile USSR.

The Rupee value of the special currency basket has been fixed at Rs.63.0402
with effect from May 31, 2010 as against the earlier value of Rs. 60.897378.

levitra

Nirav Shah

S. 11(1)(a) — Application of income should result and should be for the purpose of charitable purposes in India and application need not be in India.

New Page 1

40 (2010) 38 DTR (Delhi) (Trib.) 105
National Association of Software & Services Companies (NASSCOM) v.

Dy. DIT (E)
A.Ys. : 1998-99, 2004-05 & 2005-06

Dated : 12-3-2010

S. 11(1)(a) — Application of income should result and should
be for the purpose of charitable purposes in India and application need not be
in India.

Facts :

The assessee incurred expenditure at an event at Hannover,
Germany, which was claimed as application of income within the meaning of S.
11(1)(a). The AO and CIT(A) were of the opinion that the expenditure should have
been incurred in India in order to be eligible for exemption.

Held :

A perusal of the provisions of S. 11(1)(a) of the Act clearly
shows that the words used are ‘is applied to such purpose in India’. The words
are not ‘is applied in India’. The fact that the Legislature has put the words
‘to such purpose’ between ‘is applied’ and ‘in India’ shows that the application
of income need not be in India, but the application should result and should be
for the purpose of charitable and religious purpose in India. It is not the case
of the Revenue that the expenditure incurred by the assessee in Hannover,
Germany has not resulted in the benefit being derived in India. In these
circumstances, it cannot be said that the expenditure incurred by the assessee
in Hannover, Germany, which resulted in and which was for the purpose of
attaining the charitable object in India, is not application of income. The
decision in the case of Gem & Jewellery Export Promotion Council v. ITO, 68 ITD
95 (Mum.) was followed.

levitra

Nirav Shah

S. 145 — Entire amount of time-share membership fee receivable by assessee upfront at time of enrolment of a member is not income chargeable to tax in initial year on account of contractual obligation fastened to the receipt to provide services in future

New Page 1

32 2010 TIOL 262 ITAT (Mad.) (SB)
ACIT v. Mahindra Holidays & Resorts (India) Ltd.
A.Ys. : 1998-99 to 2002-03. Dated : 26-5-2010

S. 145 — Entire amount of time-share membership fee
receivable by assessee upfront at time of enrolment of a member is not income
chargeable to tax in initial year on account of contractual obligation fastened
to the receipt to provide services in future over term of contract.

Facts :

The assessee was in the business of selling time share units
in its various resorts. It granted membership for a period of 25/33 years on
payment of a certain amount as membership fee. During the currency of the
membership, the member had a right to holiday for one week in a year at the
place of his choice from amongst the resorts of the assessee. He also had a
right to transfer, bequeath or gift his membership/time-share unit to any
person. The membership fee was received either in lump sum or in instalments. In
addition to the membership fee, the member was liable to pay annual maintenance
charges, irrespective of whether he made use of the resort or not. These charges
were for the maintenance and upkeep of the various resorts. Additional payment
towards utilities like electricity, water, etc. was payable if the resort was
utilised. The assessee was following the mercantile system of accounting. It
treated the membership fee as revenue receipt. However only 40% of the amount
received was offered for taxation in the year of receipt and the balance was
equally spread over the period of membership of 25 or 33 years on the ground
that it was relatable to the services to be offered to the members. The
Assessing Officer (AO) held that as per the accrual system of accounting, the
entire receipt had to be assessed as income in the year of receipt; the Act does
not recognise the concept of deferred income. He made an addition of 60% of the
receipts shown by the assessee as advance subscriptions.

Aggrieved, the assessee preferred an appeal to the CIT(A) who
upheld the contentions of the assessee and deleted the addition in all the
years.

Aggrieved, the Department preferred an appeal to the
Tribunal. At the instance of the assessee a Special Bench was constituted to
consider the following question :

“Whether the entire amount of the time-share membership fee
receivable by the assessee upfront at the time of enrolment of a member is the
income chargeable to tax in the initial year when there is a contractual
obligation fastened to the receipt to provide the services in future over the
term of the contract ?”

Held :

(i) From the observations of the Supreme Court in E. D.
Sassoon & Co. Ltd v. CIT, (26 ITR 27) (SC), it is evident that two conditions
are necessary to say that income has accrued to or earned by the assessee.
They are, (i) it is necessary that the assessee must have contributed to its
accruing or arising by rendering services or otherwise, and (ii) a debt must
have come into existence and he must have acquired a right to receive the
payment. In the present case, a debt is created in favour of the assessee
immediately on execution of the agreement. However, it cannot be said that the
assessee has fully contributed to its accruing by rendering services. The
assessee is bound to provide accommodation to the members for one week every
year till the currency of the membership. Till the assessee fulfils its
promise, the parenthood cannot be traced to it.

(ii) The argument of the assessee that the main reason to
spread the balance amount of membership fee over the tenure of membership was
due to the fact that the assessee has to incur heavy expenditure for the
upkeep and maintenance of its resorts was not accepted since the assessee was
collecting separate charges for maintenance and use of utilities and therefore
it was held that matching concept cannot be pressed into service with regard
to the membership fee.

(iii) If the assessee is not able to provide accommodation
in any of its notified resorts, it will try to procure alternate
accommodation. This also will entail additional expenditure on the part of the
assessee over and above paying liquidated damages to the assessee. Unlike the
case in Calcuta Co. Ltd. (37 ITR 1) (SC), the liability in this case is
difficult not only to quantify but also to reasonably estimate it. The
liability is undoubtedly there. However, no scientific basis has been brought
to our notice to quantify the same even reasonably. Even if the assessee had
chosen to provide for the liability every year to comply with the matching
concept, it would have been wholly unscientific and arbitrary.

(iv) In the case of Rotork Controls India, 314 ITR 62 (SC),
the Supreme Court has observed that a provision is recognised when (a) an
enterprise has a present obligation as a result of a past event; (b) it is
probable that an outflow of resources will be required to settle the
obligation; and (c) a reliable estimate can be made of the amount of the
obligation. If these conditions are not met, no provision can be recognised.
In the present case, the assessee has a present obligation as a result of a
past event and outflow of resources is probable to settle the obligation.
Thus, first two conditions are satisfied. However, considering the nature of
activity, it is the third condition which is difficult to satisfy.

(v) Recognising the entire receipt as income can lead to
distortion. Somewhat similar, though not exactly identical, situation was face
by the Supreme Court in the case of Madras Industrial Investment Corporation
Ltd. v. CIT, 255 ITR 802 (SC). The only difference is that in the case of
Madras Industrial Investment Corporation the distortion was supposed to be on
account of expenditure, in the present case the distortion is on account of
the entire income being accounted in the year of receipt.

(vi) Since it is difficult to estimate the liability which
is likely to be incurred in future, more so in the absence of any scientific
basis or historical data, the only way to minimise the distortion is to spread
over a part of the income over the ensuing years.

(vii) The entire amount of time-share membership fee
receivable by the assessee upfront at the time of enrolment of a member is not
the income chargeable to tax in the initial year on account of contractual
obligation that is fastened to the receipt to provide services in future over
the term of contract.

levitra

Nirav Shah

Retrospective Tax Amendments — Rule of Law or Rule of Babus ?

IS IT FAIR

Heads I win and tails you lose ! ! ! This seems to be the
policy of our Tax Administration. There are 16 direct tax amendments in
the Finance Act, 2010 with retrospective effect, some of them coming into effect
from as far back as 1976. These amendments are aimed at overriding the judicial
pronouncements and undermining the judicial process in at least the taxation
matters. What’s worse is that this has been a disturbing trend for past many
years.

These are 150-odd retroactive amendments in direct taxes in
the past five years. With one stroke of the pen, they are reversing court
rulings. It gives tax authorities the powers to re-open cases that have been
concluded in favour of the taxpayer after long-drawn and costly litigation. Such
amendments are very unsettling. A taxpayer may have acted according to the
prevailing law, based on the language of the Act, Rules, etc. and his
interpretation of the same (which is ultimately upheld by the court) and has
made expansions or drawn up business plans. Such amendments only go to show that
the intention of the Government (in particular, of the tax policy-makers as well
as the tax administrators) is neither clearly spelt out in the Memorandum
explaining the provisions of the Finance Bills or in the Circulars explaining
the provisions of the various Finance Acts, nor proper and adequate care is
taken at the time of drafting the relevant Sections, Rules, and Circulars, etc.
This attitude is against the legitimate expectations of taxpayers regarding the
professed certainty, stability and predictability in the tax regime.

Retrospective amendments raise the following issues for
debate and discussion :

1. Are our Revenue Officials and policy-makers ‘accountable’ to anyone ?

2. Does anyone in the CBDT or the Finance Ministry or the Law Ministry track judicial decisions in tax matters right from the Appellate Tribunal stage ? Why do they wake up only when the Supreme Court/High Courts deliver favourable judgments in favour of the assessee.

3. According to press reports, our legislators hardly discuss amendments to the Tax laws. Do these amendments represent the ‘Will’ of the administrators or the ‘Will’ of the people ? Do we have rule of Law or rule of Babus ?

4. Do retrospective amendments represent disregard for judicial pronouncements ?

Retrospective amendments send a clear message to the tax officials — do not worry about the courts; frame the tax assessments in accordance with your interpretation of the law and we will take care of judicial pronouncements by way of retrospective amendment.

5. At times Circulars issued after the passing of Finance Bills, etc. are at variance with the language of the Section. This leads to avoidable litigation as the Tax officer is bound to follow the Circular.

In the circumstances, it is suggested as follows :

1. Adequate care should be taken at the time of drafting laws.

2. Immediate action should be taken to amend the law when it is discovered that there is a possible interpretation, which is against the intention behind the enactment.

3. If there are omissions/errors in drafting or if the intention of the Government is not clearly brought out in the laws drafted by the Government, which has led to prolonged litigation before the High Courts or the Supreme Court, law should be amended only ‘prospectively’. The power of the Parliament to make retrospective amendments should be used in the ‘rarest of the rare’ cases.

Courts might uphold the constitutional validity of a
retrospective amendment, but as late Shri N. A. Palkhivala said, time and again,
that what is legal is not necessarily ethical, just and fair.

levitra

Nirav Shah

Is it fair for the tax administration to knowingly indulge in wasteful paper-work ?

Is It Fair

1. Introduction :

In recent years, all the Government Departments are
embarking upon massive computerisation. Use of technology is always welcome as
it is expected to enhance efficiency and transparency. In the Income-tax Act,
there are provisions that are progressively making on-line submission of tax
returns and TDS returns compulsory. The amendments in S. 203, S. 206C(4) and
other relevant provisions are on cards for past few years. The implementation
is being postponed obviously on the ground that the whole machinery is not yet
geared up. It is a dream to allow on-line credit of taxes deducted at source
as well as of other tax-payments. There can be no two opinions about the
sanctity of the purpose. However, there appears to be excessive enthusiasm in
implementing it in the processing of returns. This is causing tremendous
hardship to the assessees.

2. Chaotic processing u/s.143(1) :

2.1 For A.Y. 2007-08, thousands of assessees have been
receiving intimations u/s.143(1) almost invariably resulting into sizeable
amount of tax-demand. The common reason in all such cases is non-giving of the
credit for TDS, advance tax and self-assessment tax.

2.2 Corporate and a few non-corporate assessees have been
pushed into the regime of on-line submission of returns. So also, for those
who are permitted to file paper-returns, are not allowed to submit any
enclosures. All the information is to be filled in the return itself. There
are columns requiring details of TDS (such as TAN of deductor) other tax
payments (such as BSR code or CIN of the Bank). On the basis of this
information, the Department is expected to allow credit. The TDS certificates
and receipted challans remain with the assessees.

2.3 The on-line information available with the Department
almost never matches with the claims made by the assessees. There are several
reasons for such discrepancies — such as non-filing of e-TDS returns by
deductors, incorrect entries made by deductor, defaults committed by deductor,
errors committed by banks in transmitting the information, other technical
problems at NSDL or other monitoring agencies and so on. On none of these
factors, the assessee has any control. He only holds original certificates and
challans. Gradually, even this is sought to be discontinued.

2.4 The obvious result is that there are huge tax demands,
panic among individual taxpayers, applications and correspondence for
rectification, repeated follow-up with the Department and all those unhealthy
consequences which are too well-known. It may so happen that the bureaucrats
may even refuse to grant credit unless the details are seen on their ‘screen’.
They will make the assessees and their representatives run from pillar to
post, with a sword of tax-demand hanging on their heads.

2.5 Needless to state that for such services, no one will
be willing to pay fees to the concerned professional. It will be a colossal
waste of man-days of our staff, our professional time, stationery and
unrequired effort. A totally futile exercise. It is a great wastage of
resources, causing unbearable botheration to all concerned — including the
staff of the Department.

3. Suggestions :

Wherever there is a mismatch between the claim and the
on-line information, the Department can send a simple interview-memo or
communication, asking the assessees to furnish relevant documents. Apparently,
the limitation of time prescribed in S. 143(1) proviso — may be a hurdle. This
can be overcome by suitable administrative instructions or even by an
amendment. It is not to suggest that the progress towards computerisation
should be stalled. But efforts should continue with a little application of
mind and human touch and without causing harassment to the ‘tax-payer’.

levitra

Nirav Shah

Is it fair to have inherent contradiction in the provisions so as to make waiver of penalty impossible ?

Is It Fair

1. Introduction :

The Income-tax Act, 1961 prescribes a variety of consequences
for default in complying with various requirements of the Act. The common
consequences are interest and penalties; and in extreme situations, prosecution
as well. The other consequences could be denial of exemptions or deductions,
denial of carry forward of losses, etc. It is now a fairly settled position that
interest is mandatory while penalty is discretionary. Unfortunately, the present
attitude of the administration is to levy penalty in a routine manner and seldom
use discretion in favour of the assessees — howsoever genuine the case may be.
Penalties are also perceived as a source of revenue — although its main
objective is to have a deterrent effect. Even the First Appellate authorities
are often reluctant to interfere. Invariably, one has to approach the Tribunals.
S. 273B provides some cushion to argue that there was reasonable cause behind
the default. In practice, however, it is hardly effective. The main penalty
which is the subject matter of this write-up is penalty u/s.271(1)(c)
vis-à-vis its waiver u/s.273A.

2. S. 271(1)(c) :

Concealment of income or inaccurate particulars :

2.1 Readers are aware that in terms of sub-clause (iii) of
Ss.(1) of S. 271(1), if there is concealment of Income or furnishing of
inaccurate particulars, as envisaged in clause (c) of S. 271(1), the penalty
imposable may be not less than, but not exceeding three times the tax sought to
be evaded. Apart from the harshness in terms of quantum, it is also a stigma on
the assessee’s tax records. Since, it is very serious, there is good amount of
litigation on this particular issue.

2.2 Disallowances u/s.40(a)(ia) or S. 43B are in most of the
cases merely in the nature of deferment of allowability. These disallowances can
hardly be called as ‘concealment’. Still, penalty provision of 271(1)(c) is
routinely invoked and penalty levied. This adds to the misery created by the
already illogical provision of S. 40(a)(ia).

3. S. 273A waiver or reduction of penalty :

3.1 Theoretically, S. 273A seeks to provide some remedy.
However, its wording is peculiar. The relevant provisions read as follows :

“S. 273A : Power to reduce or waive penalty, etc., in
certain cases:

(1) Notwithstanding anything contained in this Act, the
Commissioner may, in his discretion, whether on his own motion or otherwise
–

(ii) reduce or waive the amount of penalty imposed or
imposable on a person under clause (iii) of Ss.(1) of S. 271;

If he is satisfied that such person :

(b) in the case referred to in clause (ii), has, prior to
the detection by the Assessing Officer, of the concealment of particulars of
income or of the inaccuracy of particulars furnished in respect of such
income, voluntarily and in good faith, made full and true disclosure of such
particulars;

and also has, in the case referred to in clause (b),
co-operated in any enquiry relating to the assessment of his income and has
either paid or made satisfactory arrangements for the payment of any tax or
interest payable in consequence of an order passed under this Act in respect
of the relevant assessment year.

Explanation — For the purposes of this sub-section, a
person shall be deemed to have made full and true disclosure of his income
or of the particulars relating thereto in any case where the excess of
income assessed over the income returned is of such a nature as not to
attract the provisions of clause (c) of Ss.(1) of S. 271.”

3.2 Now, the question arises that if it is a pre-condition
that prior to the detection by the AO, the full particulars had been disclosed,
then in the first place, the penalty would not have been leviable at all. In
such case, it should be deleted as a matter of right to the assessee and it
would be a fit case to succeed in appeal. S. 273A is like a mercy petition where
the legal merit is not too strong. Question of mercy or waiver would arise only
where the penalty was legitimately leviable and the assessee has in fact
committed a default.

3.3 A safeguard is also provided in Ss.(3) to the Revenue
that such waiver can be granted only once in the lifetime of an assessee. It
cannot be resorted to again and again. Therefore, it is reasonable to expect
that the conditions should not be so rigid as to make the waiver almost
impossible. Thus, under the present law, even if a Commissioner wants to use his
discretion in favour of the assessee, it would be difficult for him to do so.

3.4 The situation is further aggravated by the recent
retrospective amendment introduced by the Finance Act, 2008. viz.
dispensing with the requirement of ‘satisfaction’ on the part of the Assessing
Officer before initiating the penalty proceedings. Refer Ss.(1B) of S. 271.

4. Suggestion :

The procedure and conditions for waiver should be made
liberal so as to make the law equitable. The present rigidity which, in fact, is
inherently self-contradictory should be removed.

levitra

Nirav Shah

ORDERS OF THE COURT & CIC

Right to information

Part A : ORDERS OF THE COURT & CIC

S. 20 and S. 29 of the RTI Act :

A writ petition was filed before the Orissa High Court by the
PIO on whom the Orissa State Information Commissioner (SIC) had imposed penalty
of Rs.19250.

Under the RTI application, certain information applied for
was not furnished within 30 days. The applicant registered a complaint against
the PIO for this default with SIC. The PIO intimated that “since the information
regarding the rate of VAT on different commodities in Oriya version was not
available in the department, the information could not be supplied being not
available”. However, he admitted that since such information had not been
prepared and not available, it was his duty to at least intimate the applicant
about the fact of non-availability of the information sought for by him within
the stipulated time.

When the matter was taken up for hearing at SIC, the
complainant did not appear, but sent a letter to the State Commissioner to
permit him to withdraw the complaint. Even then, without permitting withdrawal
of the complaint, the Commission came to hold that the petitioner who was the
dealing assistant and one Trilochan Pradhan who was the section officer were
prima facie responsible for the delay. So holding, the Commission directed
issuance of notice only to the petitioner to show cause as to why penalty as per
provisions of S. 20(1) of the Right to Information Act, 2005 should not be
attracted. Pursuant to the notice dated 12-3-2007 issued to the petitioner, she
showed cause stating that though the letter was available to her on 22-5-2006,
the single file in which such applications were dealt with was made available to
her on 17-7-2006. Hence, there was delay. However, SIC imposed the penalty due
to the alleged reason that the petitioner had retained the file from 22-5-2006
to 26-8-2006 and was found responsible for delay of 77 days. The complainant had
sought for the Oriya version of the rate of VAT on different commodities
prevailing in Orissa and if Oriya version of the VAT rate chart was not in
existence with the public authority, a simple reply within the time line would
have sufficed. But in the instant case, a negative answer was given by the
referred PIO after a delay of 77 days, which cannot be lost sight of or
condoned.

Decision of the Court :

S. 20(1) of the Right to Information Act provides that where
the Information Commissioner at the time of deciding any complaint or appeal is
of the opinion that the PIO has, without any reasonable cause,

(1) refused to receive an application for information, or

(2) has not furnished information within the time specified
under Ss.(1) of S. 7, or

(3) malafidely denied the request for information, or

(4) knowingly given incorrect, incomplete or misleading
information, or

(5) destroyed information which was the subject of the
request, or

(6) obstructed in any manner in furnishing the information,

it shall impose a penalty of two hundred and fifty rupees
each day till the application is received or information is furnished, so
however, the total amount of such penalty shall not exceed rupees twenty-five
thousand.

Therefore, this power is to be exercised only at the time of
deciding any complaint or appeal. But in this case since the complainant did not
choose to appear and sought for withdrawal of the complaint, the complaint could
not have been proceeded with. In view of the above, proceeding with the
complaint in the absence of the complainant when he is not interested to proceed
with the same is not warranted under the law and, therefore, the Information
Commission has committed manifest error of law in proceeding with the complaint
after condoning the absence when he had already sought for withdrawal.

(Author’s Note : Readers may consider whether the above is the
correct decision)

[PIO v. Orissa Information Commission, WP(C) No. 1874 of
2008, decided on 22-7-2009]

S. 8(1)(g), (h) and (j) :

Shri N. K. Bhasin made an RTI application to ICAI in respect
of the detailed verbatim proceedings of the Council of ICAI in the matter of
complaint by DGM, Bank of India [Reference No. 25-CA(88)/2002]. The CPIO
provided a reply on 17-9-2007, in which the final decision of the Council was
communicated to the appellant, but not the verbatim proceedings. The Appellate
Authority, in its order dated 12-11-2007, upheld the CPIO’s decision. Initially,
when this matter was heard by the Commission on 16-7-2008, a direction was
issued to the respondents to file their written submissions as well as the
appellant to file the counter, if any, for the Commission to process this matter
further. Accordingly, the CPIO filed his comments on 14-8-2008 and the appellant
his counter on 29-8-2008.

As the Order of the CIC is of interest to the members of our
profession, I reproduce verbatim 7 paras of the Order (as I had done in the
issue of April 2010) :

The main point brought out by the respondents is that ICAI
functions under an Act of the Parliament and the regulations framed under the
said Act specially mention the steps to be followed at every stage as well as
the information to be communicated to the parties concerned to any complaint
which the ICAI Council may be dealing with. These regulations require the
Council to specify/intimate only the prima facie opinion to the parties and not
the grounds on which such opinion is formed. No hearing is provided to the
parties at the time of forming of the prima facie opinion by the Council. The
findings of the Council are also communicated to the parties. It is, therefore,
the submission of the respondents that their statute itself makes a difference
between the prima facie opinion stage and the final stage and has provided for
the appropriate information to be given to the parties at their respective
stages. The application of the present applicant was dealt with under those
provisions.

It is the appellant’s submission that the information he has
sought was in a case which has already concluded and been closed. It is his case
that the information requested by him should be disclosed to him “blocking out
such portions of the document as would attract exemption u/s. 8(1)(g) and
u/s.8(1)(j) of the RTI Act, 2005 . . .” and the requested information could not
impede any process of investigation since no process is currently on.

The respondents were specifically asked to state as to what objection they could have to disclosure of the requested information to the appellant, especially when the matter is acknowledgedly a closed one and no investigation or enquiry is pending. They made reference to the ICAI Act and the regulations and stated that they were disinclined to provide to the appellant any documentation other than what the ICAI Act and the regulations entitled him to.

On consideration of both the submissions, it is my view that the respondents had not been able to specifically state as to how the requested information could be barred from disclosure, especially as no investigation to which it might relate is current. That excludes the purview of exemption — S. 8(1)(h) of the RTI Act. I do not see how S. 8(1)(g) or S. 8(1)(j) of the RTI Act would be applicable in the present case. The appellant has himself suggested that should the respondents consider parts of the disclosed information sensitive in terms of S. 8(1) of the RTI Act, they should be willing to block it out/sever it by invoking the provisions of S. 10(1) of the RTI Act and disclose the balance information to the appellant.

I find myself in agreement with the submission of the appellant. I do not see how any of the exemption Sections of the RTI Act would apply to the present information as requested by the appellant especially because this information pertains to an enquiry/ investigation which is already over and the matter stands closed. There is merit also in the appellant’s submission that the respondents should sever u/s.10(1) such portions of the information, which they might consider sensitive in terms of S. 8(1) of the RTI Act.

The respondents’ pleading that their disclosure of information was conditioned only by the provisions of the ICAI Act and the regulations and could not be decided under the RTI Act, cannot be accepted in view of S. 22 of the RTI Act (override Section).

In view of the above, it is directed that the requested information shall be disclosed to the appellant by the respondents/CPIO within two weeks of the receipt of this order. The respondents/CPIO may sever from the disclosed information such portions, which according to them, was sensitive and was likely to attract any of the provisions of the exemptions under the S. 8(1) of the RTI Act.

[Appellant : Shri N. K. Bhasin — Respondents : The Institute of Chartered Accountants of India, F.No. CIC/ AT/A/2008/00265 of 19-1-2010]

Part B: The RTI Act

On 31-3-2010, Govt. of India, Ministry of Personnel, Public Grievances and Pensions, Department of Personnel & Training (DoPT) had a brainstorming with Civil Society Organisations (CSO). 22 NGOs from all over India were invited. 25 individuals participated : 3 from DoPT, 2 from CIC’s office and 20 representatives of CSOs (including author of this article).

The brainstorming/consultation was to seek inputs from representatives of Civil Society — especially those who had long-standing experience in promoting RTI so that the department could bring about the intended effective improvements in its functioning as well as that of the RTI regime.

As per the presentation of the Secretary of CIC, three basic issues are considered as critical to the successful implementation of the RTI Act and which need to be set right :

Implementation of relevant provisions of S. 4 more seriously, innovatively and efficiently. He referred to a recent report of the Director General of National Archives, from which it can be made out that less than 10% of the public sector entities bothered to even report their compliance with the ‘Public Records Act, 1993’. Having a clear road map for streamlining the implementation of the Public Records Act and its operationalisation is crucial. (Note: Part B of r2i of May 2010 covers this subject).

Meticulous study of the questions/information requests that are usually received by a PA and making all such information available suo motu go a long way in lessening the burden on citizens for getting the information they seek.

Dissemination i.e., the manner in which infor-mation is made available proactively is crucial. Disclosure of information on websites is of limited or no value for the 90% populace which has no access to the Internet. Some out-of-the-box thinking for designing apt formats to address this issue is also called for.

Five members of CSOs (including Narayan Varma) were contacted in advance by the Deputy Secretary, RTI Division, DoPT and were requested to make the presentation of their views. They did so.

Dr. Vijay Kumar (National Law School of India University, Bangalore) presented his views from an academic perspective. One of his suggestions was to set up the Ombudsman in the Information Commission for continuously seeking inputs and studying good practices as also for addressing the problems that Public Authorities may face in implementing the RTI Act, 2005.

Nikhil Dey (MKSS) flagged the issue why the Information Commissions need to be ap-proached on such a large scale. Departments need to look inward to address the issue and overhaul the way they deal with proac-tive disclosure, processing of applications and disposing of first appeals. This would perhaps address the issue of so many of the Government’s own employees filing RTI applications. It will also bring about certain other much-needed reforms in the manner in which governments function.

On the whole, he felt, there was much to celebrate the RTI regime. Its success so far is a good reason to believe that there is no need for amending the Act. It is so important that representatives of the Government and of the CSOs shelve the adversarial positions that they tend to take in this regard and work hand-in-hand. It would be of great mutual help for them to meet more often — on a larger scale — and keep talking to each other.

Dr. Shekhar Singh (NCPRI) stressed the need to spread RTI awareness in rural areas and to use multi-media approaches for the same. DoPT’s funding therefore needs to be streamlined accordingly. Each Public Authority should be asked by DoPT to have a PIO specifically designated to look after the updation of the Public Authority’s pro-active disclosure. Outsourcing the work of streamlining records management needs to be considered.

Arvind Kejriwal (Parivartan) made a strong pitch for the National RTI Council. He also favoured involvement of a wider number of stakeholders and hence he proposed that the said National Council would discuss all problems related to RTI implementation and should be headed by the Minister and have 70% representation from CSOs and 15% each from Governments and Information Commissions.

Narayan Varma (PCGT) urged that DoPT be-come more proactive in its functioning and strengthen the RTI regime. He questioned as to why FAQs from DoPT’s website remains deleted even after the friction on ‘file not-ings’ between DoPT and CIC is resolved. He said that DoPT’s Annual Report should clearly mention its work on RTI in a given year. He suggested that a ‘band of 200 RTI activists’ be constituted under the aegis of the earlier-proposed National Council or otherwise to propagate RTI all over India. There is a need to have very good trainers who can train others — Train the Trainers programme. He concluded saying that there has been good progress in RTI implementation, but what remains to be done is much more.

The vision and mission of the Department of Personnel and Training was placed before the participants. The outline of the workshop was also explained. The participants then split into 4 random groups. Group I and III discussed the vision of the RTI regime and how to achieve that vision. For Group II and IV discussion was on the stakeholders and Governments as facilitators of the RTI regime.

Some of the points made out in the 4 groups were :

Create simple formats for disclosing information both proactively and reactively

Appoint a ‘dedicated PIO’, who can also be the Public Records Officer, as listed in the Public Records Act, 1993, combining the designation of PIO and Record Officer

National RTI Council be formed

‘Transparency Day’ once a month for multi-stakeholder dialogue

Joint campaigns and open houses facilitated by CSOs

Social media campaigns — street plays, songs, etc. highlighting RTI Act’s benefits be organised

Document best practices for dissemination

Reliance on Article 256 of the Constitution (whereby the Central Government can give appropriate directions to the State Governments — including those directions for better implementation of Central Law).

The Joint Secretary, DoPT wrapped up the proceedings summarising the presentations/ discussions in the previous sessions and pointed out that there was much agreement on the key issues faced by the RTI implementation regime even though there were variations in the solutions that were suggested. He also emphasised that the Government and the RTI activists were essentially working towards the same goal. He stated that the Government is fully commit-ted to the success of the RTI regime and that it would not do anything that would in any way dilute or weaken the RTI regime. He mentioned that this was a beginning of process of consultation.

PART c : OTHER NEWS

BPL individuals misusing benefit provided to them in the RTI Act :

Proviso to S. 7(5) of the RTI Act states that fee prescribed u/s.(1) of S. 6 and u/s.(1) and (5) of S. 7 shall not be charged from the persons who are of below poverty line as may be determined by the appropriate Government.

In a bid to curb the misuse of free information under the RTI Act, the Maharashtra State Information Commissioner has recommended that not more than 100 page-photocopies should be given free of cost to those below the poverty line.

Chief Information Commissioner Suresh Joshi said the clause under which information is given free of cost to below poverty line persons, was being misused. He cited a case where a person below the poverty line sought information on the Krishna Valley Development Corporation right from its inception. The information ran into five lakh pages.

“We charge Rs.2 per page. In this case, the fee would amount to Rs.10 lakh. I believe that those below the poverty line would not be interested in this kind of information. Someone was using the person to obtain information free of cost.” said Joshi.

He has recommended to the CM that if the information runs into several pages, the applicant be asked to inspect the documents and then ask for pages he wants photocopies of.

UK opens Government data to public :

Britain’s Prime Minister David Cameron has thrown open Government data to the public as part of a radical plan to usher in more transparency in public affairs.

In a letter sent to all government departments, Mr. Cameron set out ambitious plans to open up data and set challenging deadliness to public bodies for publication of information on topics including crime, hospital infection and government spending.

He states : “Greater transparency is at the heart of our shared commitment to enable the public to hold politicians and public bodies to account; to reduce the deficit and deliver better value for money in public spending; and to realise significant economic benefits by enabling businesses and non-profit organisations to build innovative applications and websites using public data.”

Housing for poor !

Aam admi always loses out to corrupt politicians. It is so sad. A whopping 85% of the flats meant for those from the economically weaker section have been usurped by our politicians. TOI has procured data through RTI application from the Urban Development Department that exposes the rampant misuse of the Chief Minister’s 5% discretionary housing quota scheme.

In 1976, the State Government initiated a housing scheme under the Chief Minister’s 5% discretionary quota which allowed citizens from the economically weaker section to apply for flats surrendered by developers in lieu of residential complexes constructed on Government land. According to the rules, each application must be thoroughly vetted by the State Urban Development Department before being approved by the Chief Minister.

Data accessed from the Urban Development Department shows that over the last 16 years, nearly 85% of the apartments have been given to Ministers, MLAs, MPs, their relatives and friends. TOI has in its possession a copy of the list of people who have been allotted flats under the Chief Minister’s discretionary housing quota scheme. Of the total 3,993 recipients, three-fourth (nearly 2,994) are from the Congress, the Shiv Sena, the BJP and the MNS.

Some of the political recipients have taken the flats in the names of their wives and children. Many sold off their apartments even before the completion of the mandatory five-year lock-in period, making a killing on the sale. A total of 142 flats were sold before the end of the lock-in period, in violation of rules framed by the Urban Development Department. Data shows that 1,008 flats have been resold with the allottees pocketing decent profits.

IS THERE NO ONE TO QUESTION SUCH ACTS ?

Gay Professor :

In Indian Institute of Technology (Hyderabad), management sacked gay rights activist and faculty member Ashley Tellis, apparently uncomfortable with his sexual orientation. The academic, with around 20 years of experience, was shown the door recently, less than a year of joining IIT-H.

Tellis has filed a right to information application, seeking the reasons behind his sacking.

Illegal garden in Navi Mumbai :

Civic activist Sandeep Thakur used the RTI Act to get facts from Navi Mumbai Municipal Corporations (NMMC). Facts are that CIDCO which built Navi Mumbai has spent Rs.12 crores to create a holding pond in Sector 10-A. It was because of this pond, Navi Mumbai escaped flooding when large parts of Mumbai went under water on July 26, 2005.

In 2008, NMMC filled up one-fifth of the pond to create a garden. This, despite the fact that there are two large public gardens just across the road.

In reply to the RTI application, the Chief Engineer of NMMC admitted that the garden was illegal. He promised last year that the pond would be restored to its original size in April that year. However, no action was taken. Things started moving only when Thakur filed a PIL in April this year asking the Court to direct the civic chief to restore the holding pond to its original capacity before monsoon.

On May 7, the High Court said it would like to know “who took the decision to develop the garden inside the holding pond” and directed the Commissioner to recover the money spent from that person. The Bench said the Commissioner would be held responsible in the matter. Commissioner Nahata has been ordered to file an affidavit before the hearing on July 20.

Mumbai Mayor’s Fund :

Nobody knew that such a fund existed (Gerson da Cunha, founder of AGNI commented : I have never heard of it. This is one of BMC’s best-kept secret). Existence of such a fund got revealed when an RTI application was made to find out details about it. The Mayor’s fund, as per the RTI records, got a shot in the arm when Mayor R. T. Kadam (1995-1996) organised a programme for fund-raising which resulted in funds of over Rs.1.26 crore. Of this, a crore was kept in fixed deposit and the interest received was used to meet medical aid for the needy. However, the irony is that Mayors who succeeded Kadam only spent the money from the kitty towards medical aid, but did nothing to increase it. When Datta Dalvi, Mayor (2005-’07) exited office, the fund had a balance of over 50.80 lakh, other than the fixed deposit.

Surprisingly, though Dr. Shubha Raul, Mayor, (2007-’09), sanctioned the maximum medical aid of over Rs.50 lakh during her tenure, her contribution to the kitty was zero. At the end of her tenure, the balance corpus was just a paltry sum of over Rs.4 lakh.

The Mayor provides financial assistance to underprivileged patients suffering specifically from heart ailments, dialysis, brain tumor, tuberculosis and kidney ailments.

Shraddha Jadhav, the present Mayor informs that she has over Rs.1 crore in deposit and is utilising the interest received from it to meet public needs. On an average, Ms. Jadhav receives (daily) five to six applications for financial help and has a balance of over Rs.4 lakh in hand. Ms. Jadhav says that she plans to organise a few fund-raising events soon.

Expenditure on newspapers by the Ministers :

An RTI inquiry reveals that the Maharashtra State Government spent over Rs.7.5 lakh from January 2009 to February 2010 on newspapers and magazines provided to the CM and Deputy CM besides various publicity departments of Mantralaya.

As per the information received in RTI reply, the CM’s office receives three copies of 24 newspapers daily including English and vernacular publications, while the Deputy CM’s office gets 19 newspapers in Marathi, Hindi and English. Interestingly, the office of the Director (Publicity) receives 33 sets of newspapers and magazines including Femina, Society and Stardust. Over 44 different newspapers and magazines are distributed in the news sections, making it highest subscriber amongst 16 departments in Mantralaya, followed by 40 publications that are received by Mantralaya library.

Shailesh Gandhi goes digital :

Mr. Gandhi selected by the Central Government as a Central Information Commissioner in September 2008 has gone digital. His communication to me and others is very interesting. He states that digital record-keeping is definitely the way forward in any office — government or otherwise. It would promote transparency and accountability in the office and reduce corruption. Full communication is posted on www.bcasonline.org and www.pcgt.org.

Nirav Shah

Conditioning

Namaskaar

‘Whatever the mind of man can conceive and believe he can
achieve’.

— Napoleon Hill

Have we ever contemplated that we live a ‘conditioned’ life
and not a thoughtful life ? We are conditioned by the acts and thoughts of our
parents, teachers, friends, peers, children and above all by our spouse. We are
even conditioned by the books we read, the movies we see, the television shows
we view, the newspapers we read and the economic and social environment we live
in and above all by our leaders in the social and political arena.

Our mode of dressing and even our eating habits are dictated
by an environment conditioned by the media. We want to get rid of strife, but we
imbibe strife from news and tele-soap operas.

For those of us who believe in the concept of Karma
our existence and actions are controlled by our past karma. In a way it is a
paradox to say that ‘one has the choice of action’, but no control over results.
The issue is : Is action not controlled by karma ? Does this mean that ‘man
lives like a robot’ ?

The problem is : Can we get rid of this conditioning — can we
live as thinking beings ?

I think one can — it will be difficult, but one can
consciously get rid of all ‘conditioning’ — it will be a painful, laborious and
long process. To condition our mind in the right direction we are advised to
study good and religious literature, have good friends, act according to the
teachings of our guru and above all listen to our conscious. All with the idea
of changing our ‘conditioning’.

The paradox of ‘conditioning’ is that by following a painful
process of getting rid of our unconscious conditioning one is getting into
another conditioning — namely — that of thinking about what motivates and
conditions our actions. Robin Sharma in his book ‘Megaliving’ says ‘The human
mind and spirit can perform miracles if properly used and conditioned for
excellence.

Let us never forget that our thoughts condition our lives. It
has been rightly said ‘Man is as he thinketh’.

Let us live a conscious conditioned life as opposed to
unconscious conditioned life. Let us make this change. This ‘changed
conditioning’ will transform us from ‘slaves’ to ‘masters’. So let us be
‘masters’.

The mind is like a muscle, if it is weak it can be
conditioned for strength.

The purpose of life is a life of purpose.

For the purposes of action nothing is more useful than
narrowness of thought combined with energy of will.

— Henri Frederic Amiel

Mentally repeat your commitment.

The essence of genius is knowing what to overlook.

— William James

Things which matter most should never be at the mercy of
things which matter least.

— Goethe

levitra

Nirav Shah

Flowering Trees

Namaskaar

It was a lovely morning. I was enjoying my walk, admiring the
beauty of nature around me, and paying my silent tribute to the creator who
created this wonderful world. My eyes rested on a tree standing tall in its
majestic glory and fully decked with lovely flowers. I started thinking about
flowering trees. How many did I know ? I could recall about twenty in my mind.
And then it dawned on me, and what I had learnt came to my mind. Every tree
(unless it be a cone bearing one) is a flowering tree ! Every tree has to have
flowers. Only we fail to see the flowers. We do not have eyes for them.

And my mind wandered further. This principle applies to us
humans too. All of us have some wonderful qualities. Every one of us is great
and unique in some special way. God has made every one of us different. No two
persons have the same fingerprints. Each one’s DNA is different. Each one of us
is gifted with some good qualities.

It is said that no one is perfect. But it is equally true
that no one is totally devoid of good qualities. A 100% hero or a 100% villain
exists only in romantic films, novels of ‘Mills and Boon’ type or in TV serials.
Even in ‘Mahabharat’, ‘Ramayana’ and other epics, we find that the authors
realised this and depicted it correctly. Even great personalities like
Bhishma and Drona were not devoid of faults and weaknesses.
Bhishma silently witnessed the dishonour of Draupadi without
attempting to stop Kauravas, and Drona for the sake of money
backed the wrong side.

On the other hand Duryodhan stood firmly besides
Karna and conferred instant princehood on Karna when he was being
humiliated because of his alleged birth in a low caste family. He also chose to
fight Bhima and met his death at his hands when he could have well chosen
any of the other four of Pandavas who were no match for him in fighting
with Gada. Karna also magnanimously gave away knowingly his
Kavatch and Kundals which were providing him with invincibility, to
God Indra who came dressed as a beggar, knowing that he was signing his
own death warrant. Even Ravana had his good qualities. Laxman was
sent by Rama to seek wisdom from Ravana, when Ravana was
dying on the battlefield.

There are also numerous instances where the latent goodness
comes out and a person gets transformed from being a sinner to a saint. We all
know how Valya the dreaded robber became saint Valmiki and gave us
the priceless gift of Ramayana. In not too a distant past Leo Tolstoy
completely changed from leading life full of vices to reach great heights. He
became a champion of poorest of poor and started living a very simple life with
only bare necessities. He became one of the three major influences in Mahatma
Gandhi’s life. There is a current case of one Laxman Gode who was sentenced
eight times for as many as 19 criminal offences. Reading Mahatma Gandhi’s work
while in jail, completely transformed him. He came out clean, confessed to his
wrong deeds and is today totally devoted to Gandhiji’s ideals. He has been
responsible for spreading Gandhiji’s message amongst hardened criminals and
transforming many of them !

In Bhagvad Gita lord Krishna describes the qualities of good
persons in the first three shlokas of the 16th Chapter.

The Blessed Lord said :

Fearlessness, cleanness of life, steadfastness in the Yoga of
wisdom, almsgiving, self-restraint and sacrifice and study of the Scriptures,
austerity and straightforwardness,

Harmlessness, truth, absence of wrath, renunciation,
peacefulness, absence of crookedness, compassion to living beings,
uncovetousness, mildness, modesty, absence of fickleness,

Vigour, forgiveness, fortitude, purity, absence of envy and
pride, all these are his who is born with the divine properties, O Bharata.

Many of us do not posses several of these. But if we look
around carefully we will certainly find these in people around us. Let us find
such people and do not hesitate to learn from them, howsoever humble and lowly
they may appear. Let us then see that the best in us comes out and the tree of
our life flowers in full bloom.

“I look only to the good qualities of man. Not being
faultless myself, I won’t presume to probe into faults of others.”

— Mahatma Gandhi

Nirav Shah

SME Sector : Legal Overview

1. Introduction :

1.1 The Small and Medium Enterprise (‘SME’) sector is the growth engine of the Indian economy. This sector is the fulcrum based on which the Indian economy would leapfrog into the next orbit. It also represents one of the largest employers in the country. As per some estimates, there are more than 12 million SMEs in the country, manufacturing over 8,000 different products and contributing about 9% of the GDP. Further, they also have a 35% share in Indian exports.

1.2 However, inspite of these statistics, one must also bear in mind that the business mortality rate is also the highest amongst this sector. Hence, it is important that they get adequate support from the Government. Recognising their importance, the Government has enacted various legal provisions to safeguard them. This Article examines the different laws/provisions which deal with the SME sector.

2. MSME Act :

2.1 The most important step taken was the enactment of the Micro, Small and Medium Enterprises Development Act, 2006 (‘MSME Act’). The Act was enacted recognising the need for a comprehensive Act to provide an appropriate legal framework to facilitate the growth and development of the SME sector and to enhance their competitiveness. This Act was officially notified in the Gazette on 18th July 2006.

2.2 The Act applies to Micro, Small and Medium Enterprises. Before understanding these three definitions, let us understand the meaning of an ‘enterprise’. It means :

an industrial undertaking/business concern/other establishment by any other name,

which is engaged in the manufacture or production of goods pertaining to an industry specified in the Industries (Development and Regulations) Act; or

which is engaged in providing or rendering any service.

Thus, it can be a manufacturer SME or a service-sector SME. A third type of an SME would not be covered. For instance, would a kirana store (a small-time grocer) be covered under this definition ? In a sector where a vast percentage of the businesses are small-time traders, one wonders why the Act did not think of covering them. There is no definition of the terms service, manufacture and production. Further, the manufacturing activity should only be of those goods which are specified in the First Schedule to the IDRA Act. It is quite strange, that the Act sought to restrict manufacturing only to a limited type of goods and did not think it fit to enlarge the canvass to cover all types of production activity.

However, the legal form of the enterprise is not relevant, i.e., it could be a sole proprietorship, partnership, LLP, company, HUF, society, AOP, any other legal entity, etc.

2.3 Under the MSME Act, the Central Government has, vide Notification dated 29th September 2006, classified enterprises as given in table below :

In calculating the investment in plant and machinery, the Government has notified certain items which should be excluded. Further, in the case of imported machinery, items such as, import duty, shipping charges, customs clearance charges and VAT should be taken into account.

2.4 There is a requirement of filing with certain designated authorities, a Memorandum known as “Entrepreneur’s Memorandum” as given below.

2.5 Where any supplier, which is a micro or a small enterprise and has filed the Memorandum, has supplied goods/rendered service to any buyer, then the buyer must make payment to him within the time agreed upon between them. The maximum duration for payment must be within 45 days from the day of acceptance. If the buyer does not pay as per this schedule, then he is liable to pay compound interest with monthly rests at thrice the bank rate notified by the RBI. Thus, the defaulter has perforce to pay interest for the period of delay at 3 times the bank rate of interest notified, from time to time, by RBI (which is presently 6% and three times thereof will be 18% p.a.) compounded with monthly rests, notwithstanding any condition to the contrary in the contract between the ‘buyer’ and the ‘supplier’. Medium enterprises are not eligible for this protection.

2.6 Disclosure in accounts:

2.6.1 S. 22 of the MSME Act requires every buyer, who is required to get his accounts audited under any law, to furnish the following information in his annual accounts:

a) The principal amount and the interest due thereon (to be shown separately) remaining unpaid to any supplier as at the end of the accounting year.

b) The amount of interest paid by the buyer in terms of S. 18, along with the amounts of the payment made to the supplier beyond the appointed day during each accounting year.

c) The amount of interest due and payable for the period of delay in making payment (which has been made but beyond the appointed day during the year) but without adding the interest specified under this Act.

d) The amount of interest accrued and remaining unpaid at the end of each accounting year.

e) The amount of further interest remaining due and payable even in the succeeding years, until such date when the interest dues are actually paid to the small enterprise, for the purpose of disallowance as a deductible expenditure u/ s.23 of the Act. This clause uses the words small enterprise. Does this mean that payments to a micro enterprise are not covered ‘by this clause?

The penalty for non-compliance is a fine which shall not be less than Rs. 10,000.

3. Schedule VI of Companies Act:

3.1 Schedule VI to the Companies Act, 1956 was also amended by Notification No. GSR 719(E)dated
16-11-2007. Part I dealing with the format of the Balance Sheet requires the following information to be provided under the heading ‘Sundry Creditors’ :

a) total outstanding dues of micro enterprises and small enterprises; and

b) total outstanding dues of creditors other than micro enterprises and small enterprises

3.2 Further, the Schedule also requires the following information (which is also required u/s.22 of the MSME Act) to be disclosed under the Notes to Accounts of the Company:

a) the principal amount and the interest due thereon (to be shown separately) remaining unpaid to any supplier as at the end of each accounting year;

b) the amount of interest paid by the buyer in terms of S. 16 of the Micro, Small and Medium Enterprises Development Act, 2006, along with the amount of the payment made to the supplier beyond the appointed day during each accounting year;

c) the amount of interest due and payable for the period of delay in making payment (which has been made but beyond the appointed day dur-ing the year) but without adding the interest specified under the Micro, Small and Medium Enterprises Development Act, 2006;

(d) the amount of interest accrued and remaining unpaid at the end of each accounting year; and

(e) the amount of further interest remaining due and payable even in the succeeding years, until such date when the interest dues as above are actually paid to the small enterprise, for the purpose of disallowance as a deductible expenditure u/s.23 of the Micro, Small and Medium Enterprises Development Act, 2006.

3.3 Saral Schedule VI:

3.3.1 The Ministry of Corporate Affairs has issued two drafts of revised Schedule VI for comments, namely Saral Schedule VI for Small and Medium Companies (SMCs) and other for Non Small and Medium Companies. ‘Small and Medium Sized Companies’ (SMCs) are defined in Rule 2(f) of Companies (Accounting Standards) Rules, 2006. SMCs are defined to mean a company which fulfills and satisfies the conditions mentioned here-under as at the end of the relevant reporting period:

i) whose equity or debt securities are not listed or are not in the process of listing on any stock exchange, whether in India or outside India;

ii) which is not a bank, financial institution or an insurance c0mpany;

iii) whose turnover (excluding other income) does not exceed rupees fifty crore in the immediately preceding reporting period;

iv) which does not have borrowings (including public deposits) in excess of rupees ten crore at any time during the immediately preceding reporting period; and

v) which is not a holding or subsidiary company of a company which is not a small and medium-sized company.

3.3.2 The proposed ‘Saral Schedule VI’ to the Companies Act, 1956has been proposed to take care of the following needs:

a) make it simple and user friendly for SMCs

b) have minimum disclosure requirements

c) ensure that the accounts have compatibility and convergence with IFRS

d) users needs are limited

4. Income-tax Act :

4.1 5.23 amends the Income-tax Act to provide that the amount of interest payable or paid by any buyer in accordance with the provisions of the Act, would not be allowed as a deduction for computing its income. Thus, in addition to the penal interest payable by the buyer, he will also have to bear the liability to income-tax thereon, as such interest on delayed payments to MSEs (whether already paid or remaining accrued due and payable) will be added to the taxable income of the buyer and subjected to income-tax, year after year, until it is finally paid to the affected supplier. Therefore, the only way for the buyers to avoid such interest and income-tax liability is to pay promptly the supplier’s bills.

4.2 In pursuance of the provisions of the MSMED Act, the CBDT has notified instructions to all assessing officers, vide their Instruction No. 12/2006 dated 14-12-2006, thereby directing them to implement:

a) The provisions u/s.22 of the said Act, which require the aforesaid disclosures, would enable the assessing officers to ascertain the correct amount of disallowance on account of interest payment or paid by the buyer, and

b) S. 23 of said Act lays down that the amount of interest payable or paid by any buyer under or in accordance with the provisions of MSME Act shall not be allowed as deduction in the computation of income.

4.3 Recently, Appendix II, in Form No. 3CD was amended by Notification No. 36/2009, dated 13-4-2009. A new item # 17A has been inserted, which requires the disclosure of the amount of interest inadmissible u/ s.23 of the Micro, Small and Medium Enterprises Development Act, 2006. Thus, by the amendment a duty is now cast also on the auditors of the (buyers) asses sees to reporting of any interest payable to such suppliers and the con-sequential disallowance of the same.

5. Role of CAs:
5.1 Chartered Accountants should bear in mind the requirements under the above laws while auditing the accounts of companies which have dealings with SMEs or which are SMEs themselves (once the Saral Schedule VI) is notified.

Nirav Shah

Learning to be dissatisfied

Namaskar

Yes. I mean it. Strange as it may sound, but just as we have
to learn to be satisfied with certain things, there are things about which we
have to learn to be dissatisfied. I am amazed at the words of wisdom contained
in our scriptures. I came across one gem recently.

The first part of the quotation speaks of three things with
which one has always to be satisfied : one’s spouse, one’s food and one’s
wealth. The second part lays down three things with which one has always
to be dissatisfied. It says that one must always be dissatisfied with
charity that one has done, ‘tapa’ (penance — the struggle that one
has undergone for progress in the right direction) and one’s knowledge.

So much is said in these few words of wisdom that it takes a
lifetime to understand, absorb and implement it.

We do a small bit of charity and start thinking that we have
given enough. We do a bit of service to others and spend the rest of our lives
singing praise of the ‘great’ work done by us. We gain a little knowledge and
consider ourselves to be full of wisdom.

The saying tells us that we should never stop giving, as our
obligation to the society is endless. As accountants we know that a cash book
always has a debit balance, as we cannot pay out more than we receive, there has
to be a debit balance all the time. So it is in life, we cannot give out more
than we receive. We must give as much as we can with all our heart and never
feel that we have done enough. In the words of Francis Bacon ‘In charity there
is no excess.’

How can we stop our tapa, that is serving others ? There is
so much need all around us, and to stop serving and becoming complacent is not
the right thing to do. The woods may be lovely, dark and deep, but ‘We have
miles to go before we sleep’. One remembers the words of Einstein. I quote :

“A hundred times everyday I remind myself that my inner and
outer life depends on the labours of other men, living and dead, and that I
must exert myself in order to give, in the measure as I have received and I am
still receiving.”

Again, learning is an unending process. It is like climbing a
mountain. As you climb higher, your horizon expands and you come to know how
much more there is to learn. One remembers the words of Sir Isaac Newton :

“I do not know what I may appear to the world, but to
myself I seem to have been only like a boy playing on the sea shore – and
diverting myself in now and then finding smoother pebbles or a prettier shell
than ordinary, whilst the great ocean of truth lay all undiscovered before
me.”

The same thought is expressed by Jim Collins in his
best-selling book ‘From Good to Great’. According to him, ‘Good is the Enemy of
Great’. There are many good companies, but only a few companies which are truly
great. So it is with us individuals. We have so many people around us, who are
really good, but are stagnated at that level. They believe that they need not,
cannot go any further, realising little that learning has no end.

So let all of us, even when we believe that we are good,
become dissatisfied with our charity, our tapa and our knowledge, shake
ourselves out of complacency, reset our goals, lift up our anchors and sail
towards being great from merely being good.

“I shall pass through this world but once

Any good therefore that I can do,

or any kindness that I can show to any human being,

let me do it now.

Let me not defer nor neglect

for I shall not pass this way again.”

levitra

Nirav Shah

Royalties and Fees for Technical Services in International Trade

Lecture Meeting

Subject : Royalties and Fees for Technical Services in
International Trade.

Speaker : Pinakin D. Desai, Chartered
Accountant, Past President, BCA.

Venue : Walchand Hirachand Hall, IMC.

Date : 7th May 2008

(1) Scope and coverage of the subject :

The learned speaker first set out the scope and coverage of
the subject he will be dealing with. He clarified that he would not be dealing
with situations where such incomes are received by resident assesses, but he
would consider situations where the resident assessee is effecting the payments
to a non-resident individual firm or company, since obligation to withhold tax
will arise only with reference to such payments. A resident payer has to put a
question to himself whether the non-resident has a liability to pay tax in India
on royalty or on fees for technical services (FTS) received by him from a
resident company. It is only then that he becomes liable to withhold tax.

(2) Fundamental Rules :

(a) Normally a person is liable to pay tax on his income in a
country in which he is resident. However, there are exceptions to this rule
e.g., A U.K. company though liable to tax in its own country on income
received in India, all the same, tax laws in India may fix a liability on such
company to pay tax in India on Income accruing, arising or received in India. In
such case a simultaneous obligation is cast on an Indian payer to withhold tax
on such payment to the U.K. company.

(b) Where a non-resident is having a business connection or
permanent establishment in a source country, say, India, then such non-resident
is liable to pay tax on income from business connection or from permanent
establishment.

(c) In respect of royalty or technical services, the
liability to Indian Tax arises even if the services are rendered outside India.
In such cases, one has to look to provisions of treaty under D.T.A. Agreement.
If the tax is payable in source country under the treaty as well as under
domestic law, then withholding at prescribed rate will have to be made. In
another circumstance where tax is payable under domestic law but not under the
treaty, or conversely tax is payable under the treaty but not under domestic
law, or where the tax is required to be paid at lower rate, then such
non-resident recipient company can make payment in each case, at a rate most
beneficial to him.

(d) Tests to be applied to applicability of treaty
provisions : It is advisable to read all provisions of the treaty since
prima facie impression about non-taxability may get negatived by some other
provisions in the treaty. To illustrate, in the India-U.A.E. treaty the articles
are saddled with a number of barriers and conditions.

(e) Concept of beneficial ownership : Concessional or
beneficial treatment is allowable, provided the recipient is the beneficial
owner of that income. Where such recipient acts only as a conduit between the
payer and the actual beneficial owner, then benefit of concession gets lost. In
Nat West case the AAR held that the company in Mauritius is only an intermediate
vehicle between the payer and the real beneficial owner. Hence, it will not get
exemption.

(3) Fees for technical services : Applicable provisions :

(a) Domestic Law : When an Indian company makes
payment of fees for technical services, then per S. 9(1) (vii) tax is leviable
regardless of situs and nature of services; whether managerial, technical or
consultancy service. All these are regarded as technical services and there is
tax withholding obligation. Technical service means a service requiring
application of required skill and knowledge of service provider. It does not
include a normal or routine commercial service; like that of an agent promoting
sales outside India of products of his principal in India. Hence, determination
of exact nature assumes importance. There are three concepts :

(i) Whether payment is for a product or a service. Where a
readymade product is acquired, there is no element of service. But when such
product is customised or tailor-made according to requirement of customer, it
involves supply of service.

(ii) Whether it is a service from equipment or whether it
is payment for user of equipment. To illustrate, where rent is paid for use of
car or house, it is payment for use of that asset. But, where the payment is
to hotel for boarding and lodging, it is a service, so also use of taxi with
driver or payment for rail or air-travel fare. In these cases use of equipment
is incidental to use of service.

(iii) Technical service v. technology-driven
service : Examples :

(a) Live telecast music event : Though this
involves use of highly sophisticated equipments, the user is in fact
interested in the product that is entertainment programmes. So also on-line
game on portal or Internet service or on-line tax information provider’s
services. All these services are technology-driven services and not
technical services.

(b) Physical service v. electronic service. Due to
development of electronics, one can instead of purchasing a book from shop
or purchasing rail or air ticket on counter can avail the same from website
or by e-booking. All the same, the nature of service remains
technologically-driven service.

(c) In recent decision of the Mumbai High Court in
Diamond Co. case reported in 169 Taxman, the Hon. Court has analysed the
concepts of technology-driven services, royalty and fees for included
services. The company was engaged in services of grading the diamonds
involving specialised knowledge of gemologists. After applying various
tests, the certificate of gradation was given. This was regarded as
technologically-driven service.

(4) Different facets of technical service :

The Supreme Court in Ishikawa jima-Harima Heavy Industries Ltd. reported in 288 ITR 409 (SC) has held that the liability to pay tax under domestic law arises only when there is a live connection or a live territorial nexus between the service and the place where services are rendered. This is a prime condition before applying S. 9(i)(vii), as the said Section itself provides that when an Indian company has availed of any technical service from non-resident in respect of source of income outside India then such payment will not be regarded as accruing in India, since such payment is for earning income from source outside India. The explanation to S. 9(i) (vii) provides a protection in this respect. If a UK company has undertaken a turnkey project or construction project in India, the project is located in India and technical services are provided by the UK company, then such services will be regarded as part and parcel of project and the same will be regarded as project executed by the UK company. The income from execution will be taxed in India. The UK company will be deemed to be having permanent establishment in India.

(5) In many treaties there is not only Article on fees for technical service, but also Article on Independent Personal Service (IPS) say professional service. If in a treaty there is no Article dealing with Fees for Technical Services (FTS),but there is Article on Independent Personal Service, such Article can make a Brazil company liable to domestic tax, if it receives fees from an Indian company, even if there is no fixed base or PE in India.

(6) Where a payment is taxable under one article of treaty, but not under another article of the same treaty, the foreign enterprise may follow beneficial rule.

(7) Fees for Induded Service (FIS) :

This primarily deals with technical service, but its coverage is narrower than fees for technical service (FTS) and is akin to S. 9(i)(vii). Under this Article, tax will be payable by a Brazilian company in India on technical services received from Indian company even though services are not performed in India and it has no PE in India.

A treaty may have two sets of Articles, one dealing with FTS and other with IPS applicable to individual or firm. In a situation where fees for technical services are taxable in India and also under Article with FTS, but not taxable under Article IPS since such FE is not having PE, then FE can follow beneficial rule whereby IPS article will override FTS Article.

(8) Fees for Induded Service (PIS) :

It primarily is applicable to FTS. A technical service becomes included service in circumstances where the person giving service makes available technical knowledge, experience, skill, know-how or process or in addition to service makes available or transfers plan or technical design. The plans of architects or designs for installation and maintenance of machinery are illustrations, which are handed over to the payer of consideration. Similarly, software developed by a technician programmer makes available the software to his customer is another instance of included service.

Where a right to use a patent is acquired by an Indian company and if before effectively putting it to use, in conjunction with it his existing process set-up, and if there is a need for modification which is also provided by FE, then this additional service can be termed as included service. The tax will be payable at the time of making payment as per Article 12(4)(a).

(9) Most-Favoured Nation Clause (MFN Clause) :

Though on plain reading of treaty tax is payable, still there may be certain Articles whereby tax may not become payable, where there is MFN protocol. This clause is generally provided at the insistence of enterprise providing the service to ensure continued patronage of service receiver. However, the receiving company can provide for its freedom to enter into contract with some other service provider in future, whereby present contract will stand modified.

(10) Procurement of designs:

Where intention of receiving enterprise is to buy a product or a customised design and not standard design, the judicial views are divided.

In Abhishek Developers v. ITO, 3719-3722/B/04 (Bang.) and in Indian Hotels Co. Ltd. v. ITO, ITA No. SS3/M/2000 (Mum.), the customised designs were considered as products. As against this, in MRPL v. DCIT, (ITA No. 1826/M/04). In Centex Merchants Pvt. Ltd. v. DCIT, (94 ITD 211 Cal.) and in TAG Report of OECD such supply was treated as technical service.

In all these contracts intent or object behind availing service needs to be looked into. Is the object to buy a service or to buy a product? There can also be a mixed contract. S. USA taxes it at 10% plus Sch. If technical service is connected with a PE, then S. 44D becomes applicable and tax will be 40% plus Sch. after deducting expenses of the P.E. i.e., on net income. The IDS will still be at 10% even if receipt by FE is effectively connected with FE’s PE. One has to keep in view the probable litigation on application of S. 40(a)(i).

(11) Royalties:

This covers payment of royalties for branded products, payment for use of LP.R.s (Intellectual Property Rights).

Traditional view is, when use of intellectual property rights is made available for commercial exploitation, the consideration received is Royalty. Similarly providing use of confidential basis of information or right which is not in public domain gives rise to royalty.

Key question to be asked by recipient of consideration is what does the payer of consideration get in return for such payment, Does he get use of IPR ?

(12) Inherent features of IPR Grants:

(a) IPR is the result of owner’s skill, effort, exertion, intellect and/ or suffering.

(b) Owners possession usually constitutes his tool of trade.

(d) Such IPRs mayor may not be registered or protected.

(e) Grantee is permitted to do what otherwise may be infringement.

(f) Grantee is enabled to do what owner could have done.

(g) Grantee can commercialise the product.

(13) Illustrative rights of copyright holder:

(a) Literary work is protected by the Indian Copyright Act (ICA)

(b) Literary work includes computer programme [So2(0) of the Indian Copy-right Act (ICA)]

(i) To reproduce work

(ii) To issue copies to public

(iii) To make translation

(iv) To make adaptation

(v) To sell or offer for sale.

(14) The learned speaker then illustrated and displayed a chart illustrating the exact nature of receipts in the hands of grantor & grantee of licence, is Product v. Underlying IPR.

Apprehended confusion ….Product v. Underlying IPR:

(15) Definition of Royalty – Expl. 2 to S. 9(i)(vi) :

This is to be viewed from point of view of payer When payer gets any of the following rights, then it is payment of royalty.Where payer is getting any right for use any patent, invention, secret formula or secret process or similar property or for use of any copyright of any scientific, literary, artistic book, (It covers music drama, software or IPR) then such payment is royalty.

(16) There are subtle differences in definition, scope of royalty including exceptions under the Income-tax Act and the definition under UN Model. The speaker elucidated those differences through display of studies. The same are as follows :

As per Explanation Z’to S. 9(1)(vi) the royalty takes in its fold consideration received for

(a) any transfer of all or any right (including the granting of a licence in respect of films or video tapes for telecast or radio broadcasting)

(b) transfer of any right to use equipment

(c) disclosure of any knowledge, experience or skill on technical, industrial, commercial matter popularly known as undivulged know-how;

Exceptions : The following is not covered
(a) Payment is for business or source of income outside India.
(b) Consideration for sale, distribution or exhibition of cinematographic films.
(c) Capital gain income from sale, transfer of IPR.

(17) U.N. Model definition:
Definition of royalties per S. 9(I)(vi) is very wide. Treaty definitions normally are more beneficial under U.N. Model, definition of royalty:
The term ‘royalties’ as used in this Article means payment of any kind received as a consideration for the use of or right to use, any copyright of literary, artistic or scientific work including cinematograph films, any patents trademark, design or model, plan, secret formula or process or for the use of or right to use industrial, commercial or scientific equipment or for information concerning industrial, commercial or scientific experience. Therefore what is not royalty is business income taxable in the country of residence.

(18) Judicial development in taxation of royalty:
(a) Asian Satellite Decision: In this case, payment was made for use of service from equipment service provider who had server and equipment at his disposal, satellite transponder was used. The payment received from such user, whether a royalty ? According to the assessee he was using only a commercial service, but per Dept. it was payment for use of process since the words in S. 9(i)(vi)are use of secret formula or process. Per the Tribunal, a formula may be secret, but process need not be secret. By use of process, the data becomes available to user, hence it is covered by term royalty. The other cases are of Grindwel Ltd. & Kotak Mahindra, holding that use of server, the consideration par-takes colour of royalty. According to speaker, these decisions require reconsideration.

(19) Equipment hire v. Service:

As definition of royalty includes consideration for use of or right to use industrial, commercial or scientific equipment, the user has to ask two questions to himself, namely:

(a) Am I requiring the use of equipment, or

(b) Am I acquiring service of the equipment?

In the former case he needs physical possession, custody and control of property. There should be no concurrent user by other and thirdly the risk of operation is with him as user.

In the latter case, treaties are not uniform e.g., the India-USA DTAA covers equipment rental also. But in India-Netherlands DTAA, it does not. Impact of MFN clause. In Belgium treaty, the scope was amended due to favourable treaty with Sweden.

(20) TDS compliance:

TDS compliance assures great importance due to rigours of S. 40(a)(i). It is advisable to take certificate u/s. 195(2) to overcome chances of disallowance of expense and also to avoid litigation on failure to deduct, confrontation on interest and penalty for non-deduction and paying tax out of own pocket. The assessee payer has no authority to decide whether tax is deductible or not. It is advisable to follow safer course of withholding tax before payment to non-resident.

The meeting terminated with a vote of thanks to the learned speaker.

Nirav Shah

Taxation of Fees for Technical Services payable to a Non-Resident — Impact of Amendment in S. 9 of the Income-tax Act by the Finance Act, 2010

1. Background :

1.1 S. 9 of the Act provides for situations where income is deemed to accrue or arise in India. S. 9 was extensively amended vide the Finance Act, 1976, to provide that in case of payments of interest, royalty or fees for technical services (FTS) received from a resident payer, income would be deemed to accrue or arise in India, except where the interest or royalty or FTS is relatable to a business or profession carried on by the resident payer outside India or for making or earning any income from any source
outside India.

1.2 The Finance Act, 2007 inserted an Explanation in S. 9 with retrospective effect from 1-6-1976 and clarified that where income is deemed to accrue or arise in India u/s.9(1)(v), (vi) or (vii), such income shall be included in the total income of the non-resident, whether or not the non-resident has a residence or place of business or business connection in India. The amendment was made to neutralise the judgment of the Supreme Court in Ishikawajima-Harima Heavy Industries Ltd. v. DIT, (2007) (288 ITR 408/158 Taxman 259).

1.3 The Karnataka High Court in Jindal Thermal Power Co. Ltd. v. Dy. CIT, (2009) 182 Taxman 252 (Kar.) has held that the explanation does not fully neutralise the Supreme Court decision. We shall deal with these two decisions in some detail in the following paragraphs.

1.4 The Finance Act, 2010 has substituted the Explanation, with retrospective effect from
1-6-1976, also to cover the situation left out earlier i.e., rendition of services in India, and provides that the income shall be deemed to accrue or arise in India whether the non-resident has rendered services in India or not.

2. Provisions of S. 4 of the Finance Act, 2010 :

Let us now examine the amendment made by the Finance Act, 2010 in some detail.

2.1 S. 4 of the Finance Act, 2010 has substituted the existing Explanation after S. 9(2) with a new Explanation as under :

“4. In S. 9 of the Income-tax Act, for the Explanation occurring after Ss.(2), the following Explanation shall be substituted and shall be deemed to have been substituted with effect from the 1st day of June, 1976, namely :

“Explanation — For the removal of doubts, it is hereby declared that for the purposes of this Section, income of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of Ss.(1) and shall be included in the total income of the non-resident, whether or not

(i) the non-resident has a residence or place of business or business connection in India; or

(ii) the non-resident has rendered services in India.”

2.2 Notes on the Finance Bill, 2010 :

The Note 4 of Notes on clauses of the Finance Bill, 2010 reads as under :

“Clause 4 of the Bill seeks to amend S. 9 of the Income-tax Act relating to income deemed to accrue or arise in India. The existing provisions contained in the Explanation occurring after Ss.(2) of the aforesaid Section provide that, for the removal of doubts, for the purposes of the said Section, where income is deemed to accrue or arise in India under clauses (v), (vi) and (vii) of Ss.(1), such income shall be included in the total income of the non-resident, whether or not, the non-resident has a residence or place of business or business connection in India. It is proposed to substitute the said Explanation so as to provide that the income of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of subsection (1) and shall be included in the total income of the non-resident, whether or not

(i) the non-resident has a residence or place of business or business connection in India; or

(ii) the non-resident has rendered services in India.

This amendment will take effect, retrospectively, from 1st June, 1976 and will, accordingly, apply in relation to the A.Y. 1977-1978 and subsequent years.”

2.3 The Memorandum to the Finance Bill, 2010 explains the background of the proposed amendment as under :

“Income deemed to accrue or arise in India to a non-resident :

S. 9 provides for situations where income is deemed to accrue or arise in India.

Vide the Finance Act, 1976, a source rule was provided in S. 9 through insertion of clauses (v), (vi) and (vii) in Ss.(1) for income by way of interest, royalty or fees for technical services, respectively. It was provided, inter alia, that in case of payments as mentioned under these clauses, income would be deemed to accrue or arise in India to the non-resident under the circumstances specified therein.

The intention of introducing the source rule was to bring to tax interest, royalty and fees for technical services, by creating a legal fiction in S. 9, even in cases where services are provided outside India as long as they are utilised in India. The source rule, therefore, means that the situs of the rendering of services is not relevant. It is the situs of the payer and the situs of the utilisation of services which will determine the taxability of such services in India.

This was the settled position of law till 2007. However, the Supreme Court, in the case of Ishikawajima-Harima Heavy Industries Ltd., v. DIT (2007) (288 ITR 408), held that despite the deeming fiction in S. 9, for any such income to be taxable in India, there must be sufficient territorial nexus between such income and the territory of India. It further held that for establishing such territorial nexus, the ser-vices have to be rendered in India as well as utilised in India. This interpretation was not in accordance with the legislative intent that the situs of rendering service in India is not relevant as long as the services are utilised in India. Therefore, to remove doubts regarding the source rule, an Explanation was inserted below Ss.(2) of S. 9 with retrospective effect from 1st June, 1976 vide the Finance Act, 2007. The Explanation sought to clarify that where income is deemed to accrue or arise in India under clauses (v), (vi) and (vii) of Ss.(1) of S. 9, such income shall be included in the total income of the non-resident, regardless of whether the non-resident has a residence or place of business or business connection in India. However, the Karnataka High Court, in a recent judgment in the case of Jindal Thermal Power Company Ltd. v. DCIT (TDS), has held that the Explanation, in its present form, does not do away with the requirement of rendering of services in India for any income to be deemed to accrue or arise to a non-resident u/s.9. It has been held that on a plain reading of the Explanation, the criteria of rendering services in India and the utilisation of the service in India laid down by the Supreme Court in its judgment in the case of Ishikawajima-Harima Heavy Industries Ltd. (supra) remains untouched and unaffected by the Explanation.

In order to remove any doubt about the legislative intent of the aforesaid source rule, it is proposed to substitute the existing Explanation with a new Explanation to specifically state that the income of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of Ss.(1) of S. 9 and shall be included in his total income, whether or not,

a) the non-resident has a residence or place of business or business connection in India; or

b) the non-resident has rendered services in India.

This amendment is proposed to take effect retrospectively from 1st June, 1976 and will, accordingly, apply in relation to the A.Y. 1977-78 and subsequent years.”

3. Supreme Court’s decision in Ishikawajima-Harima Heavy Industries Ltd. v. Director of Income-tax, (2007) 288 ITR 408 (SC) :

Since the Memorandum refers to this case, let us examine in some detail, as to what was held by the Supreme Court. Regarding the necessity of the sufficient territorial nexus, the Supreme Court held as under :

“Territorial nexus doctrine, thus, plays an important part in assessment of tax. Tax is levied on one transaction where the operations which may give rise to income may take place partly in one territory and partly in another. The question which would fall for consideration is as to whether the income that arises out of the said transaction would be required to be proportioned to each of the territories or not. [Para 26]

Income arising out of operation in more than one jurisdiction would have territorial nexus with each of the jurisdictions on actual basis. If that be so, it may not be correct to contend that the entire income ‘accrues or arises’ in each of the jurisdictions. The Authority has proceeded on the basis that supplies in ques-tion had taken place offshore. It, however, has rendered its opinion on the premise that offshore supplies or offshore services were intimately connected with the turnkey project. [Para 27]

For attracting the taxing statute there has to be some activities through permanent establishment. If income arises without any activity of the permanent establishment, even under the DTAA the taxation liability in respect of overseas services would not arise in India. S. 9 spells out the extent to which the income of non-resident would be liable to tax in India. S. 9 has a direct territorial nexus. Relief under a double taxation treaty having regard to the provisions contained in S. 90(2) would arise only in the event a taxable income of the assessee arises in one Contracting State on the basis of accrual of income in another Contracting State on the basis of residence. Thus, if the appellant has income that accrued in India and is liable to tax because in its State all residents are entitled to relief from such double taxation payable in terms of Double Taxation Treaty. However, so far as accrual of income in India is concerned, taxability must be read in terms of S. 4(2) read with S. 9, whereupon the ques-tion of seeking assessment of such income in India on the basis of Double Taxation Treaty would arise. [Para 67]

Reading the provision of S. 9(1)(vii) (c) in its plain sense, it can be seen that it requires two conditions which have to be satisfied.
The services which are the source of the income, that is sought to be taxed, have to be rendered in India, as well as utilised in India, to be taxable in India. In the instant case, both these conditions are not satisfied simultaneously, excluding that income from the ambit of taxation in India. Thus, for a non-resident to be taxed on income for services, such services need to be rendered within India, and have to be a part of a business or profession carried on by such person in India. The appellant in the instant case have provided services to persons resident in India, and though the same have been used in India, the same have not been rendered in India. [Para 71]

S. 9(1)(vii) whereupon reliance has been placed by the Revenue, must be read with S. 5, which takes within its purview the territorial nexus on the basis whereof tax is required to be levied, namely, (a) resi-dent, and (b) receipt or accrual of income. [Para 72]

Global income of a resident although is sub-jected to tax, global income of a non-resident may not be. The answer to the question would depend upon the nature of the contract and the provisions of the DTAA. [Para 73]

What is relevant is receipt or accrual of income, as would be evident from a plain reading of S. 5(2). The legal fiction created although in a given case may be held to be of wide import, yet it is trite that the terms of a contract are required to be construed having regard to the international covenants and conventions. In a case of the instant nature, interpretation with reference to the nexus to tax territories would also assume significance. Territorial nexus for the purpose of determining the tax liability is an internationally accepted principle. An endeavour should, thus, be made to construe the taxability of a non-resident in respect of income derived by it. Having regard to the internationally accepted principle and the DTAA, it may not be possible to give an ex-tended meaning to the words ‘income deemed to accrue or arise in India’ as expressed in S.

S. 9 incorporates various heads of income on which tax is sought to be levied by the Republic of India. Whatever is payable by a resident to a non-resident by way of fees for technical services, thus, would not always come within the purview of S. 9(1)(vii). It must have sufficient territorial nexus with India so as to furnish a basis for imposition of tax.

Whereas a resident would come within the purview of S. 9(1)(vii), a non-resident would not, as services of a non-resident to a resident which are utilised in India may not have much relevance in determining whether the income of the non-resident accrues or arises in India. It must have a direct live link with the services rendered in India. When such a link is established, the same may again be subjected to any relief under the DTAA. A dis-tinction may also be made between rendition of services and utilisation thereof.” [Para 74] [Emphasis supplied]

In this connection, attention is invited to Shri N. A. Palkhivala’s comments on the amendments made in S. 9(1) vide the Finance Act, 1976 in para 18 on pages 384 and 385 of ‘The Law & Practice of Income-tax’ Vol-I, 9th edition, 2004.

4. Karnataka High Court’s decision in Jindal Thermal Power Co. Ltd. v. Deputy Commissioner of Income-tax (TDS), Bangalore

Let us now also examine in some detail the decision of the Karnataka High Court in the case of Jindal Thermal Power Co. Ltd., referred to in the Memorandum explaining Provisions of Clause 4 of the Finance Bill, 2010.

The Karnataka High Court considered the aforesaid Supreme Court’s decision while considering the import of Explanation inserted after S. 9(2) and held as under :

“In this case, the counsel for the assessee relied upon the decision of the Bombay High Court in Clifford Chance v. Dy. CIT, (2009) 176 Taxman 458 to contend that the ratio of the Supreme Court in Ishikawajima-Harima Heavy Industries Ltd.’s case (supra) regarding twin criteria of rendering of service in India and its utilisation in India has not been done away with by the incorporation of Explanation to S. 9(2). The Explanation makes it clear that the tax liability is subject to the provisions of S. 9(1)(vii)(c). Thus the twin requisites laid down by the Supreme Court in Ishikawajima-Harima Heavy Industries Ltd.’s case (supra) still holds the field. The memorandum explaining the provisions although declares that the Explanation is incorporated to overcome the decision of the Supreme Court, however, the counsel submitted that the objects and reasons stated are only external aids to be used only when the text of the law is ambiguous. In the instant case it is argued that the Explanation incorporated does not offer any ambiguity to seek the assistance of external aids. Plain reading of the provision makes it unequivocal that the position of tax liability clarified in the Explanation is subject to the provisions of S. 9(1)(vii)(c).”

“The Explanation incorporated in S. 9(2) declares that ‘where the income is deemed to accrue or arise in India under clauses (v), (vi), of Ss.(1), such income shall be included in the total income of the non-resident, whether or not the resident has a residence or place of business or business connection in India.’ The plain reading of the said provision suggests that criterion of residence, place of business or business connection of a non -resident in India has been done away with for fasten-ing the tax liability. However, the criteria of rendering service in India and the utilisation of the service in India laid down by the Su-preme Court in Ishikawajima- Harima Heavy Industries Ltd.’s case (supra) to attract tax liability u/s.9(1)(vii) remains untouched and unaffected by the Explanation to S. 9(2).

When the purport of the Explanation to S. 9(2) is plain in its meaning, it is unnecessary and impermissible to refer to the Memorandum explaining the Finance Bill, 2007. Therefore, it is explicit from the reading of S. 9(1)(vii)(c) and Explanation to S. 9(2) that the ratio laid down by the Supreme Court in Ishikawajima-Harima Heavy Industries Ltd.’s case (supra) still holds the field.” (Emphasis supplied.)

5. Does the amendment adversely impact all payments for Fees for Technical Services rendered by Non-Residents ?

In the following five types of cases, payment of Fees for Technical Services rendered by Non-Residents may still not be taxable in India, subject to fulfilment of other applicable conditions :

i) Payment for FTS covered by concept of ‘Make Available’.

ii) Payment for FTS where relevant treaty does not contain FTS clause.

iii) Payments covered by exclusions provided under provisions of S. 9(1)(vii)(b) of the Income-tax Act.

iv) Payments covered by exclusions provided in the definition of FTS provided in Explanation 2 to S. 9(1)(vii) in respect of “consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head
‘salaries’.”

Fees for Independent Personal Services covered by applicable Article 14 of a tax treaty.

These five items are explained in some detail below.

5.1 Concept of ‘Make Available’ :

Many Indian tax treaties limit the scope of fees for technical services which are taxable in India by application of the concept of ‘Make Available’ discussed below :

The expression ‘make available’ used in the Article in the tax treaties relating to ‘Fees for Technical Services’ (FTS) has far-reaching significance since it limits the scope of technical and consultancy services in the context of FTS.

India has negotiated and entered into tax treaties with various countries where the concept of ‘make available’ under the FTS clause is used. India’s tax treaties with Australia, Canada, Cyprus, Finland1, Malta, Netherlands, Portuguese Republic, Singapore, UK and USA contain the concept of ‘make available’ under the FTS clause. Further, the concept is also applicable indirectly due to existence of Most Favoured Nation (MFN) clause in the protocol to the tax treaties with Belgium, France, Israel, Hungary, Kazakstan, Spain, Switzerland and Sweden.

It is interesting to note that India-Australia Tax Treaty does not have separate FTS clause, but the definition of Royalty, which includes FTS, has provided for make available concept. An analysis of the countries having the concept of make available directly or indirectly in their tax treaties with India reveals that almost all of these countries are developed nations and they have successfully negotiated with India the restricted scope of the definition of FTS as almost all of them are technology exporting countries.

In view of the above, while deciding about taxability of any payment for FTS, the reader would be well advised to examine the relevant article and the protocol of the tax treaty to decide whether the concept of ‘make available’ is applicable to payment of FTS in question and accordingly whether such a payment would be not liable to tax in the source country. He would also be well advised to closely examine the relevant judicial decisions to determine the applicability of the concept of ‘make available’ to payment of FTS in question.

The concept of ‘make available’ is still continuously subject to judicial scrutiny under different circumstances and in respect of various kinds of services. In some cases there are conflicting/differing views and in some cases the concept has not been considered/applied while examining the taxability of the payment of FIS/FTS. As the law is not yet settled, continuous and ongoing monitoring and study of various judicial pronouncements would be necessary for proper understanding and practical application of the concept in practice. It may be noted that this concept does not exist in the OECD Model.

We may draw the attention of the readers to the series of 5 articles on this topic in the Bombay Chartered Accountant Journal (November, 2009 to March, 2010). The reader would be well advised to peruse the same.

5.2 Impact of absence of FTS Clause in Indian tax treaties :

In the following Indian tax treaties, there is no Article dealing with taxation of Fees for Technical Services :

Greece, Bangladesh, Brazil, Indonesia, Libya, Mauritius, Myanmar, Nepal, Philippines, Saudi Arabia, Sri Lanka, Syria, Tajikistan, Thailand, United Arab Republic, United Arab Emirates

Wherever, the Article on Fees for Technical Services is absent in a tax treaty, such a payment is classifiable as ‘Business Profit’ under Article 7 of the relevant tax treaty and if the payee does not have a Permanent Establishment in India in terms of Article 5 of the tax treaty, the same will not be liable to tax in India. The view is supported by many judicial decisions; amongst others :

        i) Tekniskil (Sendirian) Berhard v. CIT, (1996) 222 ITR 551 (AAR);
        ii) Siemens Aktiengesellschaft v. ITO, (1987) 22 ITD 87 (Mum.);
        iii) GUJ Jaeger GmbH v. ITO, (1991) 37 ITD 64 (Mum.);
        iv) Christiani & Nielsen Copenhagan v. First ITO, (1991) 39 ITD 355 (Mum.).

In Tekniskil (Sendirian) Berhard v. CIT, a Malaysian company had entered into an agreement with a Korean company under which the Malaysian company was to supply skilled labour to work on Korean company’s barges in India. As the agreement with Malaysia did not have any Article dealing with ‘Fees for Technical Services’ and the business of providing skilled personnel was a part of the Malaysian company’s business and since taxability of the fees received by the Malaysian company was governed by Article 7 of the DTAA dealing with ‘business profits’ with the Malaysian company not having a place of business in India, the AAR held that the fees received by the Malaysian company were not taxable in India. This advance ruling has been universally followed by various Benches of the Tribunal for deciding the issue in favour of the assessee in several cases.

The reader would be well advised to study Article 5(2) of the applicable DTAA and examine whether the activities of the foreign service provider in India would constitute a Service PE, Construction PE or Installation PE. If such a PE is constituted, then the income attributable to the PE would be taxable in India, as business income in accordance with the provisions of Article 7 of the applicable DTAA.

5.3 Exclusions provided under provisions of S. 9(1) (vii)(b) of the Income-tax Act :

One also has to keep in mind the exclusion provided in S. 9(1)(vii)(b) as under :

    “(vii) income by way of fees for Technical Services payable by
        a) …………..
        b) a person who is a resident, except where the fees are payable in respect of services utilised in a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India; or
        c) ………….. (Emphasis supplied)

Thus, the assessee also needs to examine whether such Technical Services have been utilised (a) in a business or profession carried out by the assessee outside India, or (b) for the purposes of making or earning any income from any source outside India. If the answer is in the affirmative, then also such Fees for Technical Services payable to a Non-Resident would not be taxable in India.

In this connection, attention is invited to the decision of the Bangalore Bench of the ITAT in the case of Titan Industries Ltd. v. Income-tax Officer, International Taxation, Ward-19(1), Bangalore (2007) 11 SOT 206 (Bang.)

5.4 Exclusions provided in the definition of FTS provided in Explanation 2 to S. 9(1)(vii) :

Explanation 2 to S. 9(1)(vii) defines the term ‘Fees for Technical Services’ as under :

“Explanation 2 — For the purposes of this clause, ‘Fees for Technical Services’ means any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient for consideration which would be income of the recipient chargeable under the head ‘Salaries’.” [Emphasis supplied]

With regard to interpretation of the words ‘construction, assembly, . . . . . . . . or like project’, the readers’ attention is invited to the Andhra Pradesh High Court’s decision in Commissioner of Income-tax v. Sundwiger EMPG and Co., (2003) 262 ITR 110 (AP).

Further as regard to interpretation of the words ‘mining and like project’, the reader may refer to the following decisions :

a. Geofizyka Torun SP. ZO.O. (2009 TIOL 31 ARA-IT)

b. ACIT v. Paradigm Geophysical Pvt. Ltd., [2008 TIOL 362 ITAT Del]

c. Many other decisions rendered in the context of S. 44BB read with S. 9(1)(vii)

Due to space constraints we are not dealing with the above case laws in detail here. The reader also needs to examine whether such services have been excluded from the definition of FTS as defined in Explanation 2 to S. 9(1)(vii).

5.5 Fees for Independent Personal Services :

5.5.1 Article 14 is concerned with professional services and other services of an independent character. It excludes :

Industrial or commercial activities;

Services performed by an employee who is covered by Article 15 (dependent Personal Services);

Independent activities which are covered by more specific provisions of Articles 16 and 17 (e.g., Non-employee director, artistes and sportsmen, etc.);

Payments to an enterprise in respect of furnishing of the services of employees or other personnel [which are subject to Article 5(3)(b)].

5.5.2 The definition in Article 14(2) illustrates the meaning of ‘professional services’ and is not exhaustive. The expression ‘professional services’ involves any vocation requiring predominantly intellectual skills, dependent on individual characteristics of the person (pursuing that vocation) and requires specialised and advanced education or expertise in related fields.

5.5.3 Illustrations of ‘Professional’ activities :

(a) Technical and marketing consultation for :

Location of manufacturers of specialised raw materials for use in the manufacture;

Application of machines for various purposes;

Changes in design construction;

Improvement and advancement required in manufacturing

Identification of customers;

Promotion of products.

        b) Erection, assembly and commissioning
        c) Legal consultancy
        d) Tax consulting
        e) Solicitor
        f)Keeping the client abreast of matters concerning technology upgradation and development of new products, and sharing fruits of research and development.
        g) Painting
        h) Sculpture
        i) Surgery
        j) Payment to statutory auditors for carrying out audit
        k) Scientist
        l) Teacher
        m) Artist who is paid for product endorsement
        n) Consultation for :

Upgradation of quality

Increase in productivity

Developing customers in international markets

Conducting furnace trial

5.5.4 Professional Fees v. FTS :

There are overlapping areas in ‘professional services’ and in ‘technical, managerial or consultancy services’ inasmuch as a professional service can be rendered in a technical, managerial or consultancy field. In light of the possible overlap between these Articles, certain treaties exclude income covered under Article 14 from the purview of Article 12. In such cases, if at all the amount is chargeable to tax in the State of Source, it can only be under Article 14 and hence to that extent provisions of Article 12 (FTS) and Article 14 are non-competing and mutually exclusive. On the other hand, there are Indian treaties, wherein Article 12 does not expressly exclude from its purview income covered under Article 14. In such cases, it has been held in Dieter Eberhard Gustav Von Der Mark v. CIT, (1999) 235 ITR 698 (AAR) that Article 14 overrides Article 12 by applying the principle that if a case fell under more beneficial provisions of a treaty (Article 14), then it would be futile to stretch the interpretation to bring it under some other provisions of the treaty (Article 12).

Thus, payment of fees falling within the scope of Article 14 cannot be taxed as ‘Fees for Technical Services’ under Article 12.

5.5.5 While deciding about taxability of any Fees for Independent Personal Services under Article 14, the reader would be well advised to examine the relevant Article of the applicable tax treaty and the Article 4 and the definition of ‘Person’ given in the tax treaty to decide whether Article 14 would be rightly applicable to payment of the fees in question and whether the conditions of Article 14 are satisfied on the facts of the case; and accordingly determine whether such a payment would be not liable to tax in the source country. He would also be well advised to closely examine the relevant judicial decisions to determine the applicability of Article 14 to the payment in question.

6. Conclusion :

In light of the SC’s observations on the necessity of ‘territorial nexus’ in the case of Ishikawajima-Harima (supra) extracted above in para 3 above, it would be interesting to see how the Courts will interpret the law even after the amendment to S. 9, as regards the taxability of payment for fees for technical services, irrespective of territorial nexus of such fees to the Union of India.

Another incidental issue for discussion and consideration is : What is the impact of the retrospective amendment on the payer who has already remitted payment of such FTS without TDS, following the law laid down by the Courts in the aforesaid decisions. In our view, the payer should not be considered as ‘an assessee in default’ on account of any retrospective amendment carried out subsequently. Expecting the taxpayer to act on foresight of a retrospective amendment should be hit by the doctrine of impossibility of performance. Therefore, the Tax Department should not initiate any penal action or recovery proceedings against such payer.

It should be noted that India is emerging as a major service provider. If other countries also amend their tax laws on similar lines, various services provided by Indians to non-residents from India may also become exposed to taxation in foreign countries.

(Acknowledgment : We acknowledge that we have relied upon ‘The Law and Practice of Tax Treaties : An Indian Perspective’ by authors CA Rajesh Kadakia and CA Nilesh Modi — 1st Edition, 2008, for writing parts of the article. We express our sincere thanks and gratitude to the authors.)

Nirav Shah

Interpretation of Tax Treaties

Interpretation of Tax Treaties has been a very vexed issue, full of controversies and complexities. Basically tax treaties have dual nature in that they are international tax treaties between two sovereign States and at the same time they are a part of the domestic tax law of each country applying such treaties. This adds to the complexities in their interpretation. Tax Treaties fall under public international laws. There are certain commonly accepted principles of interpretation as enshrined in Vienna Convention. Interpretation also depends upon the approach adopted for the purpose. Besides this, preparatory work, rulings from Tribunals and Courts provide useful aid in interpretation of tax treaties. In this Article, an attempt is made to cull out some important principles in interpretation of tax treaties, commonly accepted as well as emanating from Indian rulings. Various sources or aids in interpretation of tax treaties are also highlighted at relevant places.

1.0 Introduction : Monist v. Dualist Views :

Tax treaties are signed between two sovereign nations by competent authorities under the delegated powers from the respective Governments. Thus, an international agreement has to be respected and interpreted in accordance with the rules of international law as laid down in the Vienna Convention on Law of Treaties, 1969. These rules of interpretation are not restricted to tax treaties but also apply to any treaty between two countries. So any dispute between two nations in respect of Article 25 relating to Mutual Agreement Procedure of the OECD/UN Model Conventions has to be solved in the light of the Vienna Convention.

However, when it comes to application of a tax treaty in the domestic forum, the appellate authorities and the courts are primarily governed by the laws of the respective countries for interpretation. Fortunately, in India, even before insertion of S. 90(2) by the Finance (No. 2) Act, 1991, with retrospective effect from 1-4-1972, the CBDT had clarified vide Circular No. 333 dated 2-4-1982 that where a specific provision is made in the Double Taxation Avoidance Agreements (DTAA), the provisions of the DTAA will prevail over the general provisions contained in the Income-tax Act and where there is no specific provision in the DTAA, it is the basic law i.e. the provisions of the Income-tax Act, that will govern the taxation of such income. This position has been upheld in many of judicial decisions in India. The prominent amongst them are CIT v. Visakhapatnam Port Trust, (1983) 144 ITR 146 (AP); Union of India v. Azadi Bachao Andolan, (2003) 263 ITR 706; CIT v. Kulandagan Chettiar (P.V.A.L.), (2004) 267 ITR 654 (SC).

Thus, in India, treaty override over domestic tax law has a legal sanction. Internationally this situation falls under Monist View, wherein International and National laws are part of the same system of law and where DTAA overrides domestic law. Some other countries which follow such a system are: Argentina, Italy, the Netherlands, Belgium and Brazil.

The other prevalent view is known as Dualistic View wherein International Law and National Law are separate systems and DTAA becomes part of the national legal system by specific incorporation/legislation. In case of Dualistic View, DTAAs may be made subject to provisions of the National Law. Some of the countries that follow Dualistic View are Australia, Austria, Norway, Germany, Sri Lanka, UK.

Interpretation of any statute, more so international tax treaties, require that we follow some rules of interpretation. In subsequent paragraphs we shall deal with rules of statutory construction.

2.0 Basic principles of interpretation of a Treaty :

Principles or rules of interpretation of a tax treaty would be relevant only where terms or words used in treaties are ambiguous, vague or are such that different meanings are possible. If words are clear or unambiguous then there is no need to resort to different rules for interpretation.

Prior to the Vienna Convention, treaties were interpreted according to the customary international law. Just as each country’s legal system has its own canons of statutory construction and interpretation, likewise, several principles exist for the interpretation of treaties in the customary international law. Some of the important principles of Customary International law in interpretation of tax treaties are as follows :

(i) Golden Rule — Objective interpretation :

Ideally any term or word should be interpreted keeping its objective or ordinary or literal meaning in mind. The term has to be interpreted contextually.

Words and phrases are in the first instance to be construed according to their plain and natural meaning. However, if the grammatical interpretation would result in an absurdity, or in marked inconsistency with other portions of the treaty, or would clearly go beyond the intention of the parties, it should not be adopted1.

(ii) Subjective interpretation :

Under this approach, the terms of a treaty are to be interpreted according to the common intention of the contracting parties at the time the treaty was concluded. The intention has to be found from the words used in the treaty and the context thereof.

In Abdul Razak A. Meman’s case’, the Authority for Advanced Rulings (the AAR) relied on the speeches delivered by Shri Manmohan Singh, Minister of Finance (as he then was) and His Highness Sheik Harridan- Bin Rashid Al-Maktoum, Minister of Finance and Industry in the presence of His Highness Sheik Zayed Bin Sultan Al-Nahyan, the President of the UAE to arrive at the intention of parties in signing the India-UAE Tax Treaty.

iii) Teleological or purposive interpretation:

In this approach the treaty is to be interpreted so as to facilitate the attainment of the aims and objectives of the treaty. This approach is also known as the ‘objects and purpose’ method.

In case of Union of India v. Azadi Bachao Andolani, the Supreme Court of India observed that “the principles adopted for interpretation of treaties are not the same as those in interpretation of statutory legislation. The interpretation of provisions of an international treaty, including one for double taxation relief, is that the treaties are entered into at a political level and have several considerations as their bases.” The Apex Court also agreed to the argument put forth by the Appellant that “the preamble to the Indo-Mauritius DTAC recites that it is for the ‘encouragement of mutual trade and investment’ and this aspect of the matter cannot be lost sight of while interpreting the treaty”.

iv) The principle of effectiveness:

According to this principle, a treaty should be interpreted in a manner to have effect rather than to be void.

This principle, particularly stressed by the Permanent Court of International Justice, requires that the treaty should be given an interpretation which ‘on the whole’ will render the treaty ‘most effective and useful’, in other words, enabling the provisions of the treaty to work and to have their appropriate effects”.

In Cyril Eugene Pereira”, the AAR held that “a tax treaty has to be given a liberal interpretation to make it workable but that would only mean ironing out of the creases, as it is called, which would be within the realm of interpretation.”

v) Principle of contemporaneity:

A treaty’s terms are normally to be interpreted ‘on the basis of their meaning at the time the treaty was concluded. However, this is not a universal principle.

In Abdul Razak A. Memans case”, the AAR observed that “there can be little doubt that while interpreting treaties, regard should be had to material contemporanea expositio. This proposition is embodied in Article 32 of the Vienna Convention, referred to above, and is also referred to in the decision of the Supreme Court in K. P. Varghese v. ITO, (1981) 131 ITR 597.”

vi) Liberal construction:

If is a general principle of construction with respect td treaties that they shall be liberally construed so as to carry out the apparent intention of the parties.

In John N. Gladden v, Her Majesty the Queen”, the principle of liberal interpretation of tax treaties was reiterated by the Federal Court, which observed: “Contrary to an ordinary taxing statute a tax treaty or convention must be given a liberal interpretation with a view to implementing the true intentions of tne parties. A literal or legalistic interpretation must be avoided when the basic object of the treaty might be defeated or frustrated in so far as the particular item under consideration is concerned.”

The Court further recognised that “we cannot expect to find the same nicety or strict definition as in modern documents, such as deeds, or Acts of F Parliament; it has never been the habit of those engaged in diplomacy to use legal accuracy but rather to adopt more liberal terms.”

(vii) Treaty as a whole – Integrated approach:

A treaty should be construed as a whole and effect should be given to each word which would be construed in the same manner wherever it occurs. Any provision should not be interpreted in isolation; rather the entire treaty should be read as a whole to arrive at its object and purpose.

To quote Prof. Roy Rohatgi”:

a) tax treaties tend to be less precise and require a broad purposive interpretation;

b) the purpose is not the same as the subjective intention of Contracting States. It refers to the goals of the treaty as reflected objectively by the treaty as a whole.

viii) Reasonableness and consistency” :

Treaties should be given an interpretation in which the reasonable meaning of words and phrases is preferred, and in which a consistent meaning is given to different portions of the instrument. In accordance with the principles of consistency treaties should be interpreted in the light of existing international law.

One thing may be noted regarding the rules of interpretation, that they are not rules of law and are not to be applied like the rules enacted by the legislature in an Interpretation Act. In Maunsel v. Olins Lord Reid observed that U They are not rules in the ordinary sense of having some binding force. They are our servants not our masters. They are aids to construction, presumptions or pointers. Not infrequently one ‘rule’ points in one direction, another in a different direction. In each case, we must look at all relevant circumstances and decide as a matter of judgement what weight to attach to any particular ‘rule”‘.

3.0 Principles of interpretation as per the Vienna Convention:

The Vienna Convention of 1969 codified the then existing public international law. Worldwide treaties are entered and interpreted taking into account provisions of the Vienna Convention. Even though India is not a signatory to this Convention, it has a great persuasive value as it is the authentic, codified customary public international law. Courts in India have recognised and referred to principles enshrined in this Convention. Some of the important Articles of this Convention which provide great help in interpretation of a tax treaty are as follows:

3.1 Article 26: Pacta stint servanda :

Every treaty in force is binding upon the parties to it and must be performed by them in good faith.

3.2 Article 27 : Internal Law and observance of Treaties:

A party to a treaty cannot invoke the provisions of internal law as justification for its failure to perform a treaty.

In India the concept of ‘Treaty Override’ is well accepted. Moreover S. 90 (2) provides that provisions of domestic tax laws vis-a-vis treaty would be applied to the extent the same are more beneficial to the assessee.

3.3 Article 30: Application of successive treaties relating to the same subject matter:

Sometimes parties to the treaty subject themselves to provisions of other tax treaties that may be entered at a later date; in such cases the provisions of that later treaty shall prevail. For example, MFN Clause in the protocol on DTA with France provided that in respect of Dividends, Interest, Royalties and FTS if India signed a treaty after 1st September 1989 with any OECD country wherein these incomes are taxed at a lower rate or the scope is narrower, then provisions of India-France Treaty would stand modified to. that extent.

3.4 Article 31 : General rules of interpretation:

Treaties should be interpreted in Good Faith in accordance with the ordinary meaning in the light of its Object and Purpose and Context.

As per this Article primacy is given to the ‘ordinary meaning’ and ‘textual approach’ while preserving the role of ‘objects and purpose’. The context for the purpose of the interpretation of a treaty shall comprise in addition to the text, including its preamble and annexes.

In Abdul Razak A. Meman’s case”, the AAR observed that “these recitals’? indicate that the purpose of entering into the treaty is to promote mutual economic relations by concluding an agreement for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and on capital”. (emphasis supplied)

Article 31(3) further provides that there shall be taken into account, together with the context:

a) any subsequent agreement between the parties regarding the interpretation of the treaty or the application of its provisions;

b) any subsequent practice in the application of the treaty which establishes the agreement of the parties regarding its interpretation; and

c) any relevant rules of international law applicable in the relations between the parties.

Further, Article 31(4) provides that a special meaning shall be given to a term if it is established that the parties so intended.

3.5 Article 33 : Interpretation of Treaties authenticated in two or more languages:

Both texts are equally authoritative, unless treaty provides or parties agree that in case of divergence, a particular text shall prevail.

Indian tax treaties invariably provide that both Hindi and English are authentic texts, however in case of divergence, the text in English shall prevail.

4.0 Extrinsic aids to interpretation of a tax treaty:

A wide range of extrinsic material is permitted to be used in interpretation of tax treaties. According to Article 32 of the Vienna Convention the supplementary means of interpretation include the preparatory work of the treaty and the circumstances of its conclusion.

4.1 According to Prof. Starke one may resort to following extrinsic aids to interpret a tax treaty-‘ provided that clear words are not thereby contradicted:

i) Interpretative Protocols, Resolutions and Committee Reports, setting out agreed interpretations;

ii) A subsequent agreement between the parties regarding the interpretation of the treaty or the application of its provisions [Article 31(3) of the Vienna Convention];

iii) Subsequent conduct of the state parties, as evidence of the intention of the parties and their conception of the treaty;

iv) Other treaties, in pari materia,in case of doubt;

Provisions in parallel tax treaties:

If the language used in two tax treaties (say treaties: X and Y) are same and one treaty is more elaborative or clear in its meaning (say treaty X) can one rely on the interpretation/explanations provided in a treaty X while applying provisions of a treaty Y?

In case of Raymond Ltd.13the Tribunal relied on the examples given in the Memorandum of Understanding concerning Fees for Included Services in respect of Article 12 of the India-US Tax Treaty while interpreting the concept of ‘make available’ under the India-UK Treaty as the language used in both the treaties is similar.

However, the views of the Indian Judiciary are not consistent in this respect. There is contradictory judgments by Indian Courts/Tribunals in this regard as mentioned below:

For:

UOI v. Azadi Bachao Andolan, (2003) 263 ITR 706 (SC)
AEG Telefunkenv. CIT, (1998) 233 ITR 129 (Kar.)
P. No. 28 of 1999, In re (2000) 242 ITR 208 (AAR)
P. No. 16 of 1998, In re (1999) 236 ITR 103 (AAR)
DCIT v. Boston ConsultingGroup Pte. Ltd., (2005) 93 TTJ 293 (Mum.)

Against:

Mashreq Bank PSC v. DOlT, (2007) 108 TIJ 554 (Mum.)
CIT v. PV AL Kulandagan Chettiar, (2004) 267 ITR 654 (SC)
CIT v. Vijay Ship Breaking Corpn., (2003)261 ITR 113 (Guj.)
Essar Oil Ltd. v. JCIT, (2006) 102 TTJ 270 (Mum.)

4.2 Technical explanation on US MC:

US has published Technical Explanation accompanying the United States Model Income Tax Convention on Nov. IS, 1996. This explanation though refers extensively to the OECD Commentary, it highlights differences and provides basic explanation of US treaty policy for all interested parties.

Similarly, there ‘is a technical explanation for the India-US tax treaty as well.

4.3 International Articles/Essays/Reports:

In DCIT v. ITC Ltd., (2003) 85 ITD 162 (Kol.) the Tribunal referred to an essay to support its observations. Similarly, in case of CIT v. Vishakhapatanam Port Trust, (1983) 144 ITR 146 (AP), the High Court obtained ‘useful material’ through international articles.

4.4 Cahiers published by IFA, Netherlands:

Cahiers were relied upon in case of Azadi Bachao Andolan’s (supra) case by the sc.

4.5 Protocol:

A protocol is an integral part of a tax treaty and has the same binding force as the main clauses therein.
[Sumitomo Corpn. v. DCIT, (2007) 110 TTJ 302 (Del.)]

Protocol to India-US tax treaty provides many ex-amples to elucidate the meaning of the term ‘make available’. Protocol to India France treaty contains the Most Favoured Nation Clause. Thus, one must refer to protocol before reaching to any final conclusion in respect of any tax treaty provision.

4.6 Preamble:

Preamble to a tax treaty could guide in interpretation of a tax treaty. In case of Azadi Bachao Andolan, the Apex Court observed that ‘the preamble to the Indo-Mauritius Double Tax Avoidance Convention (DTAC) recites that it is for the ‘encouragement of mutual trade and investment’ and this aspects of the matter cannot be lost sight of while interpreting the treaty’. These observations are very significant whereby the Apex Court has upheld ‘economic considerations’ as one ofthe objectives of a Tax Treaty.

4.7 Mutual Agreement Procedure (MAP) :

MAP helps to interpret any ambiguous term/provision through bilateral negotiations. MAP is more authentic than other aids as officials of both countries are in possession of materials/ documents exchanged at the time of signing the tax treaty which would clearly indicate the object or purpose of a particular provision. Successful MAPs also serve as precedence in case of subsequent applications.

5.0 Commentaries on DECD/UN Models:
OECD Model Commentary has been widely used in interpretation of tax treaties. Paragraph 29.3 of the July 2008 version of the Commentary on the OECD Model Convention states that: “the Commentaries have been cited in the published decisions of the courts of the great majority of Member countries. In many decisions, the Commentaries have been extensively quoted and analysed, and have fre-quently played a key role in the judge’S delibera-tions.” Phillip Baker regards the OECD Commen-taries as an aid to tax treaty interpretation in sev-eral countries. In US v. Al Burbank & Co. Ltd.,14 the US Second Circuit Court of Appeal referred to the Commentaries as an ‘aid to interpretation’.

In CIT v. Vishakhapatanam Port Trust’s case,”, the Andhra Pradesh High Court observed that “the OECD provided its own commentaries on the technical expressions and the clauses in the Model Convention. Lord Radcliffe in Ostime v. Australian Mutual Provident Society, (1960) AC 459, 480; 39 ITR 210,219 (HL), has described the language employed in these agreements as the ‘international tax language.’

Both UN and OECD Model Commentaries are great help in interpretation of tax treaties. Their importance in interpretation of tax treaties can hardly be over emphasised. [Credit Lyonnais v. DCIT, (2005)94 ITD 401 (Mum)]

Model Commentaries give the authoritative interpretation of the provisions of DTAAs. [Sonata Information Technology Ltd. v. ACIT, (2006) 103 ITD 324 (Bang.)]

UN Commentary reproduces significant part of the OECD Model Commentary and thus, OECD plays a greater role in providing standardised or systematised approach in interpretation of tax treaties.

6.0 Foreign Courts’ decisions:

In CIT v. Vishakhapatanam Port Trust’s case,”; the Andhra Pradesh High Court observed that, “in view of the standard OECD Models which are being used in various countries, a new era of genuine ‘international tax law’ is now in the process of developing. Any person interpreting a tax treaty must now consider decisions and rulings worldwide relating to similar treaties. The maintenance of uniformity in the interpretation of a rule after its international adoption is just as important as the initial removal of divergences. Therefore, the judgments rendered by courts in other countries or rulings given by other tax authorities would be relevant.”

In undernoted cases, foreign court cases have extensively been quoted for interpretation of treaty provisions:

i) Union of India v. Azadi Bachao Andolan”
(ii) CIT v. Vishakhapatanam Port Trust”
iii) Abdul Razak A. Meman’s case’?

7.0 Ambulatory v. Static Approach:

Whenever a reference is made in a treaty to the provisions of domestic tax laws for assigning meaning to a particular term, a question often arises as to what meaning is to be assigned to the said term the one which prevailed on the date of signing a tax treaty or the one prevailing on the date of application of a tax treaty. There are two views on,the subject, namely, Static and Ambulatory.

Static:

Static approach looks at the meaning at the time when the treaty was signed.

Ambulatory:

Ambulatory approach provides that one looks, to the meaning of the term at the time of application of treaty provisions. All Model Commentaries ” including the Technical Explanation on US Model Tax Convention favors ambulatory approach, however with one caution and that is ambulatory approach cannot be applied when there is a radical amendment in the domestic law thereby changing the sum and substance of the term.’

India-Australia Treaty, in para 3(2) adds the expression ‘from time to time in force’ to provide for an ‘ambulatory’ interp retation.

8.0 Ambulatory approach subject to contextual interpretation: –

Paragraph 3 of the OECD Model Convention provides that meaning of the term not defined in the treaty shall be interpreted in accordance with the provisions of the lax laws of the Contracting State that may be applying the Convention. However, this provision is subject to one caveat and that is if the context requires interpreting the term ‘otherwise’, then the meaning should be assigned accordingly. For example, India-US treaty provides that assignment of meaning under the domestic law t9 any term not defined in the treaty shall be according to the common meaning agreed by the Competent Authorities pursuant to the provisions of Article 27 (Mutual Agreement Procedure). And if it is not so agreed then only meaning would be assigned from the domestic tax law that too provided the context does not require otherwise.

In case of Union of India v. Elphinstone Spinning and Weaving Co. Lid.,”, the Supreme Court observed that “when the question arises as to the meaning of certain provisions in a Statue it is not only legitimate but proper to read that provision in its context. The Context means the statute as a whole, the previous state of law, other statutes in pari materia, the general scope of statute and the mischief that it was intended to remedy.”

In Pandit Ram Narain v. State of Uttar Pradesh”, the Supreme Court observed that the meaning of words and expressions used in an Act must take their colour from the context in which they appear.

9.0 Objectives of Tax Treaties:

Objectives for signing a tax treaty also playa significant role in its interpretation as they determine the context in which a particular treaty is signed. For example, OECD and UN Model Conventions have different objectives to achieve. The same are as follows:

9.1 OECD Model Convention:

Principal objectives of the OECD Model Convention are as follows:

The principal purpose of double taxation conventions is to promote, by eliminating international double taxation, exchange of goods and services and the movement of capital and persons. It is also a purpose of tax conventions to prevent tax avoidance and evasion”.

9.2 UN Model Convention:

Principal objectives of the UN Model Convention are as follows: .

To protect taxpayers against double taxation (whether direct or indirect)
To encourage free flow of international trade and investment
To encourage transfer of technology
To prevent discrimination between taxpayers
To provide a reasonable element of legal and fiscal certainty to the investors and traders
To arrive at an acceptable basis to share tax revenues between two States
To improve the co-operation between taxing authorities in carrying out their duties.

9.3 Indian Tax Treaties:

S. 90 of the Income-tax Act, 1961 contains the objectives of signing tax treaties in general. The same areas follows :

a) for the granting of relief in respect of :

i) income on which taxes have been paid, both income-tax under this Act and income-tax in that country; or

ii) income-tax chargeable under this Act and under the corresponding law in force in that country to promote mutual economic relations, trade and investment”, or

b) for the avoidance of double taxation of income under this Act and under the corresponding law in force in that country, or

c) for exchange of information for the prevention of evasion or avoidance of income-tax chargeable under this Act or under the corresponding law in force in that country, or investigation of cases of such evasion or avoidance, or

d) for recovery of income-tax under this Act and under the corresponding law in force in that country.

Thus, it can be observed that there are several objectives for entering into tax treaties by the Government of India besides the primary objective of avoidance of double taxation as enumerated in clause (b) above. Besides avoidance of double taxa-tion, Indian treaties are aimed at achieving two more important objectives, namely, ‘prevention of fiscal evasion and recovery of taxes’.

The amendment made by the Finance Act,”2003, to the Indian Income-tax Act, 1961, clarifies that the Government may enter into tax treaty for the purposes of ‘promotion of mutual economic relations, trade and investment’. This amendment is more in the nature of clarification because there are several existing treaties whose preambles suggest that they were entered into for the purposes of encouragement of mutual trade and investments and/ or pro-motion of mutual economic relations. For example, treaties with Mauritius, Turkmenistan, UAE, Germany, Ukraine”, and Switzerland’? are entered into for various economic reasons, besides the main objectives of avoidance of double taxation and prevention of fiscal evasion.

10.0 Conclusion:

There is a famous saying by one judge in his order. He wrote “Language at best is an imperfect instrument for the expression of human thoughts and emotions”. It is the inadequacy of language which creates lot of communication gaps in application of a tax treaty. Determination of intent of parties, prevalent at the time of entering into agreement, after considerable lapse of time is a herculean task in absence of “Travaux Preparatories’ i.e. Prepara tory work.

Tax Treaties are result of prolonged negotiations between two Contracting States. Ideally, therefore the same should be interpreted keeping in mind the objectives with which they are entered into. Minutes of negotiations, exchange of notes, letters etc. are important material in determining the object of a particular treaty provision. However, absence of any such document in public domain makes the task of interpretation very difficult.

Interpretation of tax treaties is an evergreen subject of controversy considering the complexities involved. Application of international rules of interpretation while giving effect of provisions under the domestic law creates further confusion. Even courts are not unanimous in their rulings. A general technical explanation on the lines of India-USA tax treaty may be published by the Indian Government to reduce the disputes in interpretation of tax treaties.

Nirav Shah

Concept of ‘Beneficial Owner’ in Tax Treaties — Canadian Tax Court’s decision in case of Prévost Car Inc, — (Part I)

International Taxation

Overview :

Tax
treaties use the terms ‘beneficial owner’, ‘beneficially owned’ and ‘beneficial
ownership’ in various Articles dealing with taxation of interest, dividends,
capital gains and royalties and fees for technical services. These terms are not
defined anywhere in any of the Model Conventions or any of the Indian tax
treaties or in the Income-tax Act. The situation is no different in foreign tax
jurisdictions and foreign tax treaties.

In the absence of definition of the said terms in the tax
laws or in the tax treaties, interpretation thereof poses great challenge when
granting/claiming benefit of lower rate of tax in the hands of the ‘beneficial
owner’ in terms of applicable Article of a tax treaty.

Not much guidance is available from Indian judicial
decisions, particularly in the context of interpretations of the terms as used
in various Indian tax treaties.

Recently, the Canadian Tax Court examined the issue in depth
in the case of Prévost Car Inc (Citation 2008 TCC 231) vide judgment dated 30th
April, 2008, in the context of payment of dividends to a Netherlands holding
company.

This Article analyses the said Canadian decision.

1. Facts of the case :

(i) Prévost is a resident Canadian corporation which
declared and paid dividends to its shareholder Prévost Holding B.V. (‘PHB.V.’),
a corporation resident in the Netherlands.

(ii) The Revenue assessed on the basis that the beneficial
owners of the dividends were the corporate shareholders of PHB.V., a resident
of the United Kingdom and a resident of Sweden, and not PHB.V. itself. When
Prévost paid the dividends, it withheld tax by virtue of Ss.212(1) and
Ss.215(1) of the Act. According to Article 10 of the Tax Treaty, the rate of
withholding tax was 5%.

(iii) The Revenue contended that the assessee was required
to withhold and remit to the Crown 25% of the dividends paid to PHB.V.

(iv) The appellant was incorporated under the laws of
Quebec and is resident of Canada. It manufactures buses and related products
in Quebec and has parts and services facilities throughout North America.

(v) In 1995, the assessee’s erstwhile shareholders agreed
to sell their shares of the appellant to Volvo Bus Corporation, a resident of
Sweden and Henlys Group PLC (‘Henlys’), a resident of the United Kingdom.
Volvo and Henlys were parties to a Shareholders’ and Subscription Agreement
(“Shareholders’ Agreement”) under which Volvo undertook to incorporate a
Netherlands resident company and subsequently transfer to the Dutch company
all of the shares Volvo acquired in Prévost; the shares of the Netherlands
company would be owned as to 51% by Volvo and 49% by Henlys.

(vi) Volvo and Henlys were both engaged in the manufacture
of buses, Volvo manufacturing the chassis and Henlys, the bus body. Prévost
was in the same business, building coaches for different types of buses and
bus body shells.

(vii) PHB.V. was established as a vehicle for Henlys and
Volvo to pursue multiple North American projects. The first of these projects
was Prévost. The second was to be a Mexican company, Masa.

(viii) The Shareholders’ Agreement also provided, among
other things, that not less than 80% of the profits of the appellant and PHB.V.
and their subsidiaries, if any, (together called the ‘Corporate Group’) were
to be distributed to the shareholders.

(ix) The amounts of dividends in question were paid by the
appellant to PHB.V. and then distributed by PHB.V. to Volvo and Henlys in
accordance with the Shareholders’ Agreement.

(x) The Canada Revenue Agency acknowledged that it did not
dispute that the dividends in question were properly declared by the appellant
and paid to PHB.V.

(xi) At the relevant time PHB.V.’s registered office was in
the offices of Trent International Management PHB.V. (‘TIM’), originally in
Rotterdam and later in Amsterdam. TIM was affiliated with PHB.V.’s banker,
Citco Bank.

(xii) In 1996, the directors of PHB.V. executed a Power of
Attorney in favour of TIM to allow it to transact business on a limited scale
on behalf of PHB.V. PHB.V. executed another Power of Attorney in favour of TIM
to allow it to arrange for the execution of payment orders in respect of
interim dividend payments to be made to PHB.V.’s shareholders.

(xiii) PHB.V. had no employees in the Netherlands, nor does
it appear that it had any investments other than the shares in Prévost.

(xiv) According to KYC documentation, PHB.V. represented
that the beneficial owners of the shares of Prévost were Volvo and Henlys, not
PHB.V. itself.

2. Treaty & OECD Model Conventions :

(i) The assessee company withheld tax of (six and) five
percent on the payment of the dividends to PHB.V., relying on paragraphs 1 and 2
of Article 10 of the Tax Treaty, which read as under :

1. Dividends paid by a company which is a resident of a
Contracting State to a resident of the other Contracting State may be taxed in
that other State.

2. However, such dividends may also be taxed in the State
of which the company paying the dividends is a resident, and according to the
laws of that State, but if the recipient is the beneficial owner of the
dividends, the tax so charged shall not exceed :

(a) 5% of the gross amount of the dividends if the
beneficial owner is a company (other than a partnership), that holds
directly or indirectly at least 25% of the capital or at least 10% of the
voting power of the company paying the dividends;

Sub-paragraph (a) of paragraph 2 of Article 10 of the Tax Treaty was replaced effective January 15, 1999 as follows:

(a) 5% of the gross amount of the dividends if the beneficial owner is a company (other than a partnership) that owns at least 25% of the capital of, or that controls directly or indirectly at least 10% of the voting power in, the company paying the dividends;

(ii) The Tax Treaty is based on the Organisation for Economic Cooperation and Development (‘OECD’) Model Tax Convention on Income and on Capital 1977 (‘Model Convention’).

(iii) Paragraphs 2 of Article 10 of the Model Convention and the Tax Treaty require that the recipient of dividends be the ‘beneficial owner’ or, in French, ‘le beneficiaire effectif’ of the dividends. The words used for ‘beneficial owner’ and ‘Ie beneficiaire effectif’ in the Dutch version of the Treaty is uiteindelijk gerechtigde. These words are defined neither in the Model Convention, nor in the Tax Treaty. The French version of the Act generally uses the words ‘proprietaire effectif or ‘personne ayant la proprieie effective’ for ‘beneficial owner ‘.

(iv) The Commentary on Article 10 of the 1977 _ OECD Model Convention states that:

12. Under paragraph 2, the limitation of tax in the State of Source is not available when an intermediary, such as an agent or nominee, is interposed between the beneficiary and the payer, unless the beneficial owner is a resident of the other Contracting State. States which wish to make this more explicit are free to do so during bilateral negotiations.

Canada has not undertaken any negotiations with the Netherlands to make paragraph 2 of Article 10 of the Tax Treaty any more explicit.

(v) In 2003 the OECD Commentaries to Article 10 of the OECD Model Convention were modified. Paragraphs 12, 12.1 and 12.2 of the Commentaries explain that the term ‘beneficial owner in Article 10(2) of the Model Convention’ is not used in a narrow technical sense, rather, it would be understood in its context and in light of the object and purposes of the Convention, including avoiding double taxation and the prevention of fiscal evasion and avoidance. With respect to conduit companies, a report from the Committee on Fiscal Affairs concluded “that a conduit company cannot normally be regarded as the beneficial owner if, though the formal owner, it has, as a practical matter, very narrow powers which render it, in relation to the income concerned, a mere fiduciary or administrator acting on account of the interested parties”.

(vi) In 1995, Article 10, paragraph 2 of the Model Convention, 1977 was amended by replacing the words ‘if the recipient is the beneficial owner of the dividends’ with ‘if the beneficial owner of the dividends is a resident ofthe other Contracting State’. (There was no change to this wording in the Tax Treaty.) The Commentary was also amended to explain that the Model Convention was amended to clarify the first sentence of the original commentary above, ‘which 7 See paras. 62-64 infra. has been the consistent position of all member countries’. The second sentence of the Commentary was not altered. The key words, as far as these appeals are concerned, in both the 1977 and 1995 versions of the GECD Model Convention and the Tax Treaty, are ‘beneficial owner’ and the equivalent words in the French and Dutch languages.

(vii) Article 3(2) of the Tax Treaty provides an ap-proach to understanding undefined terms :

2. As regards the application of the Convention by a State, any term not defined therein shall, unless the context otherwise requires, have the meaning which it has under the law of that State concerning the taxes to which the Convention applies.

In other words, when Canada wishes to impose our income tax, a term not defined in the Tax Treaty will have the meaning it has under the Act, assuming it has a meaning under the Act.

(viii) The Income Tax Conventions Interpretation Act, at S. 3, directs how the meaning of undefined terms in a tax treaty are to be understood:

3. Notwithstanding the provisions of a convention or the Act giving the convention the force of law in Canada, it is hereby declared that the law of Canada is that, to the extent that a term in the convention is

(a) not defined in the convention,

(b) not fully defined in the convention, or

(c) to be defined by reference to the laws of Canada, that term has, except to the extent that the context otherwise requires, the meaning for the purposes of the Income Tax Act has changed.

(ix) The Vienna Convention on The Law of Treaties (‘VCLT’), at Article 31(1), states that:

A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and are the light of its object and purpose.

(x) Tax treaties are to be given a liberal interpretation with a view of complementing the true intentions of the contracting states. The paramount goal is to find the meaning of the words in question.

(xi) Article 3(2) of the GECD Model Convention 1977 is similar to Article 3(2) of the Tax Treaty:

… [A]s regards the application of the Convention by a Contracting State any term not defined therein shall, unless the context otherwise requires, have the meaning which it has under the law of that State concerning the taxes to which the Convention applies.

(xii) In 1999 Article 3(2) of the Model Convention, was amended as follows :

2. As regards the application of the Convention at any time by a Contracting State, any term not defined therein shall, unless the context other-wise requires, have the meaning that it has at that time under the law of that State for the purposes of the taxes to which the Convention applies, any meaning under the applicable tax laws of that State prevailing over a meaning given to the term under other laws of that State.

(xiii) The concept of ‘beneficial ownership’ or ‘beneficial owner’ is not recognised in the civil law of Quebec or other civil law countries who are members of GECD.

3. Expert evidence:

The assessee-company produced several expert witnesses to explain Dutch law and the development of the GECD Model Conventions and the Commentaries on the Model Conventions.

3.1 Professor Dr. S. van Weeghel:

He is a Professor of Law and practises taxation law in the Netherlands. He is an expert in Dutch tax treaties, Dutch tax law and abuse of tax treaties.

3.1.1 Professor van Weeghel concluded that under the Dutch law, PHB.V. is the beneficial owner of Prevost’s shares. He relied, in particular, on an interpretation by the Hoge Raad (Dutch Supreme Court) 6 April 1994, BNB 1994/217, sometimes called the ‘Royal Dutch’ Case. Based on the Hoge Raad’s interpretation, Professor van Weeghel concluded that:

. . . a clear and simple rule emerges. A person is the beneficial owner of a dividend if (i) he is the owner of the dividend coupon, (ii) he can freely avail of the coupon, and (iii) he can freely avail of the monies distributed. One could read the formulation of this rule by the Court so as to leave open the question whether the freedom to avail of the coupon or of the distribution must exist in law or in fact, or both. The reference to the wording pertaining to the ‘zaakwaarnemer’ and the ‘lasthebber’, however, seems to require a narrow reading of the ruling, i.e., one in which the freedom must exist in law. The addition of these terms cannot be read as a further condition, because a zaarkwaarnemer and a lasthebber by definition cannot freely avail of the dividend. Thus the addition must be seen as a clarification of the conditions of free avail and the zaakwaarnemer and the lasthebber both lack that freedom in law.

3.1.2 The assessee’s counselled evidence that the Canada Revenue Agency, or its predecessor, and the Dutch tax authorities disagreed who was the ‘beneficial owner’ of the dividends received from Prevost. The Dutch are of the view PHB.V. was the ‘beneficial owner’. The appellant requested competent authority assistance relating to the term ‘beneficial owner’ in Article 10(2) of the Tax Treaty. There was some communication between the tax authorities of Canada and the Netherlands, but when the Dutch and Canadian views differed as to whether the beneficial ownership requirement in Article 2 of the 1986 Convention affected situations similar to those in the appeals at bar, the Canadian authorities terminated the competent authority review.

3.1.3 Professor van Weeghel stated that under Dutch law, PHB.V. would be considered as the beneficial owner of the dividends. However, if PHB.V. were legally obligated to pass on the dividends to its shareholders, Dutch law would consider PHB.V. not to be the beneficial owner of the dividends.

3.2 Professor Rogier Raas

Professor Rogier Raas is a professor in European banking and securities law at the University of Luden in the Netherlands. Since 2000 he has practised law; he also acts as counsel to corporations and financial institutions on finance-related and regulating matters .

3.2.1 Professor Raas opined that the dividends received by PHB.V. were within the taxing authority of the Dutch government and that, but for the participation exemption granted by the Dutch government to PHB.V., PHB.V. would have been subject to Dutch tax in respect of the dividends. Despite the existence of a Shareholders’ Agreement between Volvo and Henlys and the Powers of Attorney granted to TIM, PHB.V. itself was not contractually or otherwise required to pass on the dividends it received from the appellant. In all cases, dividend payments had to be authorised by PHB.V.’s directors in accordance with Dutch law and practice. The Shareholders’ Agreement and Powers of Attorney did not have any effect on the ownership of the dividends by PHB.V., he stated.

3.2.2 In respect of the impact of the dividend policy in the Shareholders’ Agreement on the powers of PHB.V., Professor Raas concluded that:

(a) the dividend policy in the Shareholders’ Agreement does not provide for a limitation of the powers of the Board of Directors of PHB.V. that is uncommon in a Netherlands law context. A considerable influence of share-holders on the dividend policy of a Dutch B.V. is very common; and

(b) unlike the default scenario or where annual profits are at the disposal of the general meeting of PHB.V.’s shareholders, the Board of Directors had the discretion under PHB.V.’s Articles of Association and the dividend policy to decide the adequacy of the working capital requirements, before dividends were paid.

3.2.3 The revenue responded that Professor Raas assumed incorrectly that PHB.V. had a dividend policy independent of that of the Corporate Group set out in the Shareholders’ Agreement and referred to in PHB.V.’s Articles of Association. Instead, the respondent’s counsel argued, the discretion of the directors of PHB.V. to determine the adequacy of working capital of PHB.V.was inextricably tied to the same determination being made by the directors of Prevost. The proviso in the Shareholders’ Agreement on the payment of not less than 80%of the after-tax profits of the Corporate Group was limited only by a determination of the Board of Directors of both PHB.V. and Prevost ‘as to the adequacy of normal and foreseeable working capi-tal requirement of the Corporate Group at the time of each dividend payment. The dividend policy of PHB.V.,as described in the Raas report, was in fact a resolution of purported shareholders of Prevost, represented as Volvo and Henlys, and adopted by the Board of Directors of Prevost, both occurring on March 23, 1996.

3.2.4In short, the Revenue submitted that the dividend policy in the Shareholders’ Agreement, the shareholder and director resolutions of March 23, 1996, coupled with the authorisation in PHB.V.’s Articles of Association to pay interim dividends defined the scope of the discretion of the directors of the PHB.V.to determine its working capital requirement. This discretion was purely academic.

3.3 Mr. Daniel Luthi:

3.3.1 Mr. Daniel Luthi, a graduate in law, worked in the Swiss Ministry of Finance and negotiated about 30 tax treaties on behalf of Switzerland. He was also a member of the Swiss delegation to the – – “DECO Fiscal Committee, member of OECD Committee on Fiscal Affairs (‘CFA’), a member and chairman of the Swiss delegation to the OECD Working Party 1 on ‘Double Taxation, as well as a member of the OECD Informal Advisory Group in international tax matters.

3.3.2 Mr. Luthi’s report was essentially a fact-driven recollection of events that transpired during OECD Model Convention discussions and negotiations. Mr. Luthi testified on matters relating to the term ‘beneficial owner’ and to the issues facing drafts-men of the OECD Convention more for background than for anything else.

3.3.3 The term ‘beneficial owner’ was introduced into Article 10(1)of the 1977OECD Convention, Mr. Luthi stated, so as to explicitly exclude intermediaries in third States, such as agents and nominees, from treaty benefits. Article 10(1)still caused concern as to whether the shareholder was entitled to treaty benefits in a case where the dividend was received by an agent or nominee, but not the shareholder directly. Hence Article 10(1) was further amended in 1995.

3.3.4 Mr. Luthi could find ‘no traces’ why the term ‘beneficial owner’ had been chosen in the 1977 OECD Convention. Other terms were considered, for example, ‘final recipient’. The intention was that the ‘beneficialowner’ of the incomebeing a resident of the other Contracting State was to benefit from a treaty, not an agent or nominee who is not considered to be the beneficial owner of the income.

3.3.5 There was no expectation that a holding company was a mere agent or nominee for its share-holders, that is, that its shareholders were the beneficial owners of the holding company’s income. Indeed, a holding company is the beneficial owner of dividend paid to it, unless there is strong evidence of tax avoidance or treaty abuse.

3.3.6 Conduit Companies:
Mr. Luthi referred to the CFA Report of 1987, Double Taxation Conventions and the Use of Conduit Companies. An OECD working party’s report on conduit companies adopted by the OECD Council on 27 November 1986 distinguishes between two types of conduit companies, direct conduit companies and ‘stepping-stone’ conduits; the former is the conduit discussed here and is described as follows:

Direct conduits :

A company resident of State A receives dividends, interest or royalties from State B. Under the tax treaty between States A and B,the company claims that it is fully or partially exempted from the with-holding taxes of State B. The company is wholly owned by a resident of a third State not entitled to the benefit of the treaty between States A and B. It has been created with a view to taking advantage of this treaty’s benefits and for this purpose the assets and rights giving rise to the dividends, interest or royalties were transferred to it. The income is tax exempt in State A, e.g., in the case of dividends, by virtue of a parent-subsidiary regime provided for under the domestic laws of State A, or in the convention between States A and B.

He summarised the CFA’s report as follows:

… According to this Report, OECD does not deny every conduit company the ability to be the beneficial owner by stating “The fact that the conduit company’s main function is to hold assets or rights is not itself sufficient to categorise it as a mere agent or nominee, although this may indicate that further examination is necessary”. On the other hand, a conduit company cannot normally be considered to be the beneficial owner of the income received if it has very narrow powers, performs mere fiduciary or administrative functions and acts on account of the beneficiary (most likely the shareholder). In the view of OECD, such a company has only title to property, but no other economic, legal or practical attributes of ownership. In such a case, the company, based on a contract by way of obligations taken over, will have similar functions to those of an agent or a nominee.

According to Article 4 of the OECD Model Convention, a conduit company, in order to be entitled to claim treaty benefits, must be liable to tax in its residence country on the basis of its domicile, place of management, etc. In addition, the assets and rights giving rise to the income must have effectively been transferred to the conduit company. If this is the case, the conduit company cannot be considered to act as a mere agent or nominee with respect to the income received.

The analysis, observations and conclusions by the Tax Court will be discussed in Part II of the Article which will appear in the next issue of the Journal.

Nirav Shah

Debate over mobile phones and cancer

New Page 1

47 Debate over mobile phones and cancer

Three prominent neurosurgeons told the CNN interviewer Larry
King that they did not hold cell-phones next to their ears. “I think that the
safe practice ,” said Dr. Keith Black, a surgeon at Cedars-Sinai Medical Centre
in Los Angeles, “is to use an earpiece so you keep the microwave antenna away
from your brain.”

Dr. Vini Khurana, an associate professor of neurosurgery of
the Australian National University who is outspoken critic of cellphones, said
“I use it on the speaker-phone mode. I do not hold it to my ear.” And CNN’s
chief medical correspondent, Dr. Sanjay Gupta, a neurosurgeon at Emory
University Hospital said that like Dr. Black he used an earpiece.

Along with senator Edward Kennedy’s recent diagnosis of a
glioma, a type of tumour that critics have long associated with cellphone use,
the doctors’ remarks have helped reignite a long-simmering debate about cell
phones and cancer.

That supposed link has been largely dismissed by many
experts, including the American Cancer Society. The theory that cellphones cause
brain tumours “defies credulity”, said Eugene Flamm, chairman of neurosurgery at
Montefiore Medical Centre.

(Source : The Times of India, 4-6-2008)

levitra

Nirav Shah

After Warren Buffett, who ?

New Page 1

46 After Warren Buffett, who ?

Warren Buffett speaks

At the 1996 annual meeting, an investor asked what would
happen to Berkshire Hathaway if Buffett were to get hit by a truck. The question
pops up more often than toast at breakfast. “I usually say I feel sorry for the
truck,” Buffett sometimes quips. Over the years he’s tried various come backs.

1985 : In an article about Berkshire’s long-term
commitment to the company it acquires, Buffett noted : “The managers have a
corporate commitment and therefore need not worry if my personal participation
in Berkshire’s affair ends prematurely” (A term I define as any age short of
three digits.)

1986 : “This is the proverbial ‘truck’ question that I
get asked every year. If I get run over by a truck today, Charlie (Munger) would
run the business, and no Berkshire stock would need to be sold. Investments
would continue.”

Also, Buffett surmised that the stock might “move up a
quarter or a half point on the day that I go. I’ll be disappointed if it goes up
a lot.”

(Source : The Times of India, 25-5-2008)

levitra

Nirav Shah

Bust that stress

New Page 1

45 Bust that stress

Stress is evil and can only wreak havoc on our mind, body and
spirit. One can learn to cope with the following survival kit :

First, find out what’s causing the stress. A relationship issue, financial
loss, failure, an accident or a change that’s not necessarily negative, like
shifting to a new house, a mar-riage or a long trip can be the source. Some
common stressors are a violent parent or spouse, a bullying boss, being
trapped in a bad marriage or job, excessive workload or responsibilities, a
medical illness or chronic pain, or memories from a trauma, like sexual abuse.

It’s equally important to become aware of your individual coping style. Find
out what you perceive as the cause of stress and how you’re emotionally
responding it.

Once identified, you need to evaluate how many changes you could incorporate
in your environment and even in yourself. The assessment has to be honest and
realistic. You can seek advice from within the family or friends or take
professional help.

Learn to tell the difference between facts and fears. You can only deal with
reality and then treat your fears.

Don’t constantly micromanage, Learn to accept uncertainty and your limitations
in certain situations.

Know your limits — don’t be too competitive or expect too much of yourself.

Avoid comparing your finances and happiness with those who are better off.

Accept offers of practical help. Don’t hesitate to reach out and talk to
someone.

Try to spend time with people who are rewarding rather than critical and
judgmental.

Learn time management and relaxation techniques. Exercise !

(Inputs from
Dr. Bharat R. Shah, Psychiatrist, Lilavati Hospital, Mumbai)

(Source :
The Times of India, 25-5-2008)

levitra

Nirav Shah

Acts of exemplary leadership

New Page 1

44 Acts of exemplary leadership

1. Be
authentic

2. Establish
and maintain credibility

3. Create an
environment of respect and trust

4. Sense and
diagnose the work environment

5.
Communicate clearly

6.
Demonstrate common sense leadership

7. Manage

8. Inspire
hard work, attention to detail, and a commitment to quality.

(Source :
Internet news wires)

levitra

Nirav Shah

Indian carriers save Rs.15 cr. by switching over to e-tickets

New Page 1

43 Indian carriers save Rs.15 cr. by
switching over to e-tickets

Within a week of shifting from carbonised air-tickets to
e-tickets, the Indian air carriers have managed to save estimated Rs.15 crore,
providing them a way to cut costs after the rise in Aviation Turbine Fuel (ATF)
prices.

(Source : Internet news wires)

levitra

Nirav Shah

Independent directors on audit firm boards

New Page 1

42 Independent directors on audit firm
boards

U.S. Treasury panelists recommended independent directors at
auditing firms to improve their governance and transparency as well as to help
protect investors.

Currently, the largest accounting firms — Deloitte & Touche (DLTE.UL),
Ernst & Young (ERNY.UL), KPMG (KPMG.UL) and PricewaterhouseCoopers (PWC.UL) — do
not have independent directors
and are at times criticised for lacking transparency.

Panelists assembled by the Treasury Department to develop
recommendations for the industry said they were “particularly intrigued by the
idea of independent board members with duties and
responsibilities similar to those of public company non-executive board
members.”

(Source : Internet news wires)

levitra

Nirav Shah

Audit quality

New Page 1

41 Audit quality

More than three-quarters (78%) of audit committee members who
participated in a recent survey commissioned by the Center for Audit Quality
rated overall audit quality ‘very good’ or ‘excellent,’ and 82% said it has
improved in recent years.

About 53% of the audit committee members agreed that overall
audit quality is ‘very good,’ while 25% described it as ‘excellent.’ About 87%
said the risk of inaccuracies in financial statements due to fraud is ‘not very
high,’ and 60% agreed that the risk declined after the passage of the
Sarbanes-Oxley Act.

Nearly two-thirds (65%) agreed that investors should have
more confidence in the markets as a result of the 2002 law.

The Internet survey of 253 audit committee members was
conducted between Jan. 7 and Feb. 20 by The Glover Park Group. Participants in
the survey represented a range of publicly-traded companies. All served on at
least one audit committee in 2007. Six in 10 served on two or more audit
committees, and half were committee chairs. About 56% began their service as
audit committee members prior to the passage of SOX.

Nearly all of the respondents (99%) said they devote more
time to their committee work as a result of SOX. About 90% said they work more
closely with external auditors.

(Source : Internet news wires)

levitra

Nirav Shah

PCAOB norms

New Page 1

40 PCAOB norms

The Public Company Accounting Oversight Board today adopted
rules for annual and special reporting of information and events by accounting firms that are registered with the PCAOB.

S. 102(d) of the Sarbanes-Oxley Act of 2002 provides that
each registered public accounting firm shall submit an annual report to the
Board, and also may be required to report more frequently, to provide
information specified by the Board. The reporting requirements in the new rules
are the first such requirements adopted by the Board.

PCAOB Chairman Mark Olson said, “With today’s action, the
Board is putting in place requirements that will ensure that fundamental
information about each of the more than 1,800 firms registered with the PCAOB is kept up-to-date and that each firm promptly discloses certain
significant events. With this foundation in place, the Board can also, in the
future, add other reporting and disclosure obligations that may appropriately
serve the public interest.”

The reporting framework includes two types of reporting
obligations. First, each registered firm must annually provide basic information
about the firm and the firm’s issuer-related practice over the most recent
12-month period. Information to be reported annually includes, among other
things, information about audit reports issued by the firm during the year,
certain disciplinary history information about persons who have joined the firm,
and information about fees billed to issuer audit clients, in various categories
of services, as a percentage of the firm’s total fees billed.

Second, the rules and forms adopted by the Board identify
certain events that, if they occur with respect to a registered firm, must be
reported by the firm within 30 days. These reportable events range from such things as a change in the firm’s name or contact information to the
institution of certain types of legal, administrative, or disciplinary
proceedings against a firm or certain categories of
individuals.

The Board will make each firm’s annual and special reports
available to the public on the Board’s web site, subject to exceptions for
information that satisfies specified criteria for confidential treatment.

(Source : Internet news wires)

levitra

Nirav Shah

Management-oriented auditing

New Page 1

39 Management-oriented auditing

Today, the idea of detection or verification being the
‘be-all and end-all’ of internal auditing still prevails, but with improvements.
(It is not, however, the sole reason for internal auditing, which will be
explained in this article.)

The detailed checking to detect errors and fraud is giving
way to user-friendly systems designed to do the same thing. Internal auditors
today rely on up-to-date systems, which they have tested, to guard against
improprieties.

They substitute their knowledge of risks, operating goals,
systems, and management drudgery of item-by-item checking. They have moved from
simple verifiers/attesters to the broad management-orientated internal auditing.

Attributes of management-orientated auditor. He is not an
internal adversary, but a ‘management confidante’ whose role is akin to an
“internal consultant’s”. He is not the dreaded internal sleuth but a management
ally. Even though his role might be likened to the ‘eyes and ears of
management’, this attribute need not be associated to a spy or a snooper.

Modern-day internal auditors do what the chief executive
officer, manager or supervisor of an organisation would do in appraising
operations if he (that is, the CEO/manager) himself had the time.

Management-orientated auditing fundamentals. To be an
effective modern-day management-orientated internal auditor, a person needs to
be aware of the following skills : (i) knowing the modern methods, (ii) the
people they deal with, (iii) the population or audit universe to cover, (iv) how
and when to communicate (entailing good interpersonal skills), (v) knowing the
professional audit standards for his guidelines, (vi) awareness of his audit
goals, vii) knowing the facts surrounding the things he is auditing, (viii)
being aware of the controls in those surroundings, (ix) the causes of deviations
in those surroundings, (x) what effects that could arise as a result of the
present situation and finally, (xi) being able to suggest improvements or
positive (not negative) corrections.

(Source : Internet news wires)

levitra

Nirav Shah

FM’s observations at CC & DG meeting

New Page 1

38 FM’s observations at CC & DG meeting

The Finance Minister of India, Mr. P. Chidambaram, in his
inaugural address delivered at the 24th Annual Conference of Chief Commissioners
and Directors General of Income Tax in New Delhi on
the 9th June 2008, congratulated the Income Tax Department for direct tax
collection of Rs.3.14 trillion.

He, however, observed that the quality of tax scrutiny could
further improve if tax authorities repose more trust on taxpayers and not view
every case generated by the computer-aided scrutiny selection with suspicion.

[Source : Press Release No. 402/92/2006-MC (24 of
2008) Govt. of India/Ministry of Finance 17-6-2008]

levitra

Nirav Shah

Education needed for move to IFRS

New Page 1

37 Education needed for move to IFRS

All eyes are on the Securities and Exchange Commission as it
prepares to issue a detailed roadmap this summer for the transition to
International Financial Reporting Standards, but some representatives gave hints
about what might be in that roadmap at a conference held by the Financial
Accounting Standards Board in New York.

FASB Chairman Bob Herz likened the move to IFRS, while
accountants continue to use U.S. generally accepted accounting principles, to
“trying to ride two horses at once.” He said FASB was in the process of updating
its memorandum of understanding with the International Accounting Standards
Board on convergence, but said it was up to the SEC to give a date for the
transition.

AICPA CEO Barry Melancon said a modification of the Tax Code
by Congress would be the best way to handle differences such as the
last-in/first-out inventory method, which is not supported in IFRS. “The LIFO
issue is primarily a tax issue,” he said. He sees growing awareness among
corporate CPAs of the move to IFRS. He believes the time is now to set a date
certain for the transition. “You converge, converge, converge, but at some
point, you have to adopt,” he said.

(Source : Internet wires)

levitra

Nirav Shah

Tax sleuths do some serious networking

New Page 1

36 E&Y : Merger volume plunged 30%

Total global deal volume weighed in at $ 1 trillion during
the first 19 weeks of 2008, down nearly 30% from $ 1.4 trillion during the same
time last year, according to a new analysis by Ernst & Young LLP’s Transaction
Advisory Services group.

Nevertheless, deal activity remains strong in emerging
markets. So far in 2008, total transaction volume surged more than 14%, to
$ 90.7 billion in the so called BRIC countries (Brazil, Russia, India, and
China).

The infrastructure, financial services, real estate, oil and
gas, media and entertainment and technology sectors lead overall transaction
volume, according to E&Y. Because of their currently undervalued assets, those
sectors also have the biggest chance to stimulate a market rebound, the firm
added.

(Source : CFO.com, 16-6-2008)

levitra

Nirav Shah

E&Y : Merger volume plunged 30%

New Page 1

36 E&Y : Merger volume plunged 30%

(Source : CFO.com, 16-6-2008)

levitra

Nirav Shah

Are speculative traders parasites or making gold from dross ?

New Page 1

34 Are speculative traders parasites or making gold from
dross ?

The global financial market has become ‘a monster,’
responsible for ‘massive destruction of assets,’ according to the President of
Germany and former head of the IMF, Horst Kohler. It ‘grotesquely’ remunerates
its executives, he added.

According to Kenneth Griffin, founder and head of the $ 20
billion Citadel Investment Group — one of the biggest and most successful
American hedge fund companies — international finance has been functioning on
the judgment of ’29-year-old kids’ who ‘control the capital markets of
America . . . young guys right out of business school.’

As a general rule, the margin required to buy an oil futures
contract is 10%. Pledge $ 10,000 and buy $ 100,000 worth of oil. Or why be a
piker ? Put up $ 100,000 and buy a million-dollar contract. The price goes up
one dollar five minutes later and you’ve made a million.

These are not transactions between producers and consumers,
when the classical economic rules would function. These trades, unregulated,
have virtually no useful economic role. They have become a form of parasitical
professional gambling that distorts the transactions between producers and
buyers.

Kohler compared the speculative bankers with alchemists, who
purported to make gold from dross. It is not a bad comparison, and our
contemporaries have, thus far, done better than their medieval counterparts, who
often ended burned at the stake.

(Source : Daily News & Analysis, 25-5-2008)

levitra

Nirav Shah

Ex-UBS staff charged over tax fraud

New Page 1

33 Ex-UBS staff charged over tax fraud

Two bankers, including a former employee of UBS, the world’s
leading wealth manager, have been charged by US authorities with helping an
American billionaire evade income taxes on about $200 million of assets
deposited in Swiss and Liechtenstein bank accounts.

(Source : Business Standard, 15-5-2008)

The new alchemists

levitra

Nirav Shah

Group Risk Management

Overview :

‘Group Risk’ refers to risks that arise to an organisation either internally or externally as part of a ‘group’. The group consists of entities and organisations (mostly companies) under the same management.

Generally, especially in India, businesses were started and developed by families that are often referred to as ‘Groups’. These companies are under the same management, operating under the same umbrella. They often share the same ideology, may have similar style of management and functioning and may share some common facilities and may even have shared/common employees and consultants. In such a case, risk that affects any one company can spread to others within the group and also to the entire group due to ‘contagion effect’. This risk may pertain to issues like failure of controls and occurrence of fraud, which will result in tainting of the entire group.

How, to what extent and why the risk will spread within the group and affect it, will depend on the type of risk, the nature and functioning of the group.

There are certain risks that are self-limiting that will not spread out and affect beyond certain limit, whereas others, especially non physical ones where emotions and sentiments are at play may even spread across the entire group.

Thus physical risks like flood or fire may affect only those units in the group that share common facilities or infrastructure or physical space and are inter-connected in that sense. Certain non physical risks like image risk may spread easily across the group with a common management.

The example selected for this month’s case study is that of a group led by a flagship company that makes rubber products and has other companies dealing in construction and real estate, software, consumer goods, travel and tourism, advertising and printing within the group.

Supreme Rubber Products Ltd. is the flagship company of the Biju group of companies. Biju group was founded and came into prominence during the lifetime of Biju Sirkar, who set up number of units and became a well-known successful first generation entrepreneur about 50 years back, in the post independence era. The group consists of about 20 companies with interests in rubber products, construction, real estate, software, consumer goods, travel and tourism, advertising and printing.

Some of these companies are listed, others are subsidiaries or closely held, but all of them are under the same management and share a common logo. These companies operate from three main centers in Kolkata, Bhubaneshwar and Hyderabad. They share a common brand and group logo, and organisational and management practices including HR and training facilities.

Biju is now advanced in age and although the Chairman of the flagship company, is looking for a successor.

Out of the companies, the flagship company and the consumer goods company are doing extremely well. The travel and tourism, printing, real estate and the construction company are facing difficulties due to economic downturn. The software company however belying expectations and market trends, is doing quite well.

Biju being advanced in age the pressure of work and handling of diverse businesses is telling on him. His health is a cause of concern as he had a heart problem that was detected a few months back hence he quickly needs to find a successor. There are two major factions in the group. The elder son of Biju — Gopal and the other his nephew Randhir are power centres and each has been running a company. Gopal manages real estate and construction and Randhir the software company. Both have aspiration to head and control the group.

Although well respected in the market the group has an autocratic style of functioning and relies on discipline and loyalty rather than on professional managers, systems processes, procedures, controls and governance.

It is rumored that Randhir has aligned himself with the opposition in the state, and the ruling party at the centre has not taken it well.

There is some anxiety among the employees about Biju’s health. They are concerned as to what will happen to the companies in Biju’s absense. This has unsettled them.

The real estate and construction company had received a notice of enquiry regarding excess utilisation of FSI and charging that the higher floors in its latest high rise are unauthorised. The media which was generally appreciative of the group had shown some signs of discomfort in the tone of their reporting of this incident.

There are unrelated developments, for example :

the auditor of the advertising company which had come out with a public issue last year has resigned citing personal reasons.

the consumer goods company that had the largest number of employees in the group is facing worker unrest, as they wanted a raise to gain parity with pay scales of other group companies.

the flagship rubber products company has received a show cause notice from the pollution control board in respect of effluent discharged from its factory near Bhubaneshwar.

The above various aspects and issues involve potential risk to the group as a whole apart from the companies that are involved.

As a risk manager for the group you are expected to deal with the risk and present an action plan at the ensuing group meeting that is even otherwise expected to be stormy due to the power struggle within the group.

The solution:

The suggested strategy is outlined and implemented as below:

Any risk analysis requires that we first identify the nature of the risk and the level to which it may affect the company or its operations. Since all risks identified here (with the exception of the pollution incident) are man-made and internally focussed, the solutions need to be internally directed. The pollution incident is a man-made external event.

The first and foremost risk, in our opinion, is the power struggle within the group that may end up splitting the group. The group has to firstly formulate a succession plan, that would involve identifying the successor. This could be achieved by identifying fixed production/profit targets that need to be achieved (through honorable means) within an agreed timeframe. This would ensure an open and impartial evaluation as to who is best placed to lead the group into the future and would eliminate the need for internal conflicts.

The immediate problem is the incident of pollution control, that too involving the flagship company. It is not only an environment risk, but may also result in the closing down of the company due to legislative controls. The Company has to consider:

taking immediate cleaning efforts to mitigate the effects of the pollution.

training and sensitisation Company’s management and staff with the environmental regulations.

taking steps to implement safe good manufacturing practices And put in place environmental controls.

The other immediate problem is that of labour unrest. The group needs to:

identify the differences in salaries and other benefits between companies within the group, and between companies in the same industry.

control the labour unrest that would affect productivity.

take corrective action which would help retain the top talent by rationalising salary and pay scales.

develop cogent and common HRD practices.

develop a system of inter-changing medium level personnel within functions and group companies.

The next risk is to the group’s name/reputation that may result from the malpractices that have been reported in the press regarding the construction company, the labor unrest, and environment issues.

The steps suggested are:

the construction company must forthwith undergo a serious examination of all current and past projects to identify questionable practices and take corrective action, if any, required. The group needs to identify a system of internal control that will ensure that transgression of law are avoided.

to identify laws which need to be complied by all group companies.

to identify laws, rules and regulations to distinctly identifiable business.

to put in place processes to ensure compliance with laws.

This exercise may even highlight suspect practices indulged in by the two contenders who wish to head the group.

The group should also have an effective media policy nad have a media manager and public relations expert to project the company viewpoint to the various stakeholders and the public.

Lastly, the company must identify and address the concerns of the employees regarding the failing health of the group’s patron and the future of the group. This will not only fortify the group’s already failing morale but also help stem the tide of senior personnel who are apparently leaving for personal reasons. Further, as a long term plan the group should consider succession plans for all key personnel within the organisation, to help ensure transparency, a future road map for prospects for promotion, career development and growth for the employees. Such a plan will also ensure continuity of operations for the companies within the group.

The solution is indicative and illustrative in nature and represents the author’s views. The actual solution will vary, as there cannot be a single right or feasible solution or otherwise.

Nirav Shah

Infringement vs. Passing – off

IPR Laws

This month’s article seeks to explain a fundamental aspect of
the law on trademarks, the distinction between an action for infringement of a
registered trademark and an action for passing off. Whilst the former is a
statutory wrong the latter is a tort under common law. This distinction is
crucial for any trademark owner to strategise the maintenance of their trademark
portfolios.

A trademark is a mark which connects the goods and/or
services of a person with that person in the course of trade and thereby
distinguishes it from the goods and/or services of others. The Trade Marks Act,
1999 (‘the Act’) more specifically defines a trademark, inter alia, as a mark
capable of being represented graphically and which is capable of distinguishing
the goods or services of one person from those of others.¹Therefore,
a mark in order to be a trademark need not necessarily be registered. A
trademark may also either be used or proposed to be used. These factors as to
whether a trademark is used and/or registered are factors relevant for
determining whether an action for infringement of trademark and/or an action for
passing off may be instituted.

I shall initially explain what is meant by infringement of a
registered trademark and passing off, respectively, and then proceed to deal
with the broad distinctions.

Infringement of Registered Trademark :

Chapter IV of the Act deals with the effect of registration
of a trademark. The Act specifically provides that no proceedings for
infringement of an unregistered trademark may be instituted thereby clarifying
that an action for infringement can only be taken in respect of a registered
trademark. In fact, a right granted on registration is the right to take
recourse to infringement proceedings.² The Act also clarifies that an
action for passing off will not be affected by the Act.³

S. 29 of the Act deals with and identifies the acts that
would constitute infringement of a registered trademark. The Section seeks to
protect a registered trademark and/or a mark deceptively similar thereto from
being exploited and/or used by an unauthorised person so as to defeat the rights
of the registered proprietor of the trademark of being entitled to exclusively
use the registered trademark. The scope and ambit of acts constituting
infringement has been substantially broadened under the present Act by bringing
in concepts like dilution of trademark, erosion of distinctive character of the
trademark, parallel importation and damage to reputation, etc.

The statutory law relating to infringement of trade-marks is
based on the same fundamental idea as the law relating to passing off. But it
differs from that law in two particulars, namely, (1) it is concerned only with
one method of passing off, namely, the use of a trademark and (2) the statutory
protection is absolute in the sense that once a mark is shown to offend, the
user of it cannot escape by showing that by using something outside the actual
mark itself he has distinguished the goods from those of the registered
proprietor.⁴

In an infringement action, the plaintiff is, ordinarily, only
required to prove that the defendant is using the registered trademark and/or a
mark deceptively similar thereto in respect of the same goods or services cause
that would be enough to show a violation of the rights conferred on the
registered proprietor. Infringement consists in using the mark per se as a
trademark and therefore, any other distinguishing factors that may be employed
by a defendant may not be relevant in an infringement proceeding.

Any person trespassing on the rights conferred by
registration of a trademark infringes the registered trademark. The rights
conferred by registration in a particular case must be determined in the context
of any restrictive conditions or limitations entered on the Register of Trade
Marks at the time of registration of the mark.

Infringement proceedings, thus, enable a registered
proprietor to prevent any unauthorised person from using his trademark and/or
mark deceptively similar thereto in respect of similar goods or services or as
contemplated u/s.29 of the Act.

Passing off :

On the other hand, the object of the law of passing off is to
protect some form of property — usually the goodwill of the plaintiff in his
business or his goods or his services or in the work which he produces. The
trademark represents the reputation and goodwill of a business and/or the goods
and/or the services. For example, the goods sold by ‘Nike’ are considered to be
of superior quality and have an immense reputation in the market. The goods sold
under the trademark ‘Nike’ carry immense value on the basis of the fact that
they bear the ‘Nike’ trademark. If the same goods were sold without the said
trademark thereon, they would not be as valuable.

Passing off is a form of tort of deceit and/or
misrepresentation. To put it in a nutshell, passing off is a tort whereby one
person tries to pass off his goods and/or services as and for the goods and/or
services of another. Passing off in effect is also a form of unfair competition.
It is a common law remedy and has been built entirely on the basis of case law.

In Halsbury’s Laws of England, 4th Edn., Volume 48, para 144
at page 98, the essentials of the cause of action for passing off, as restated
by the House of Lords in Erven Warnink B. V. v. J. Townend & Sons, 1980 R.P.C.
31, are set out as follows :

“(1) a misrepresentation

(2) made by a trader in the course of trade

(3) to prospective customers of his or ultimate consumers
of goods or services supplied by him

(4) which is calculated to injure the business or goodwill
of another trader, in the sense that this is a reasonably foreseeable
consequence, and

(5) which causes actual damage to a business or goodwill of
the trader by whom the action is brought or, in a quia timet action, will
probably do so.”

The aforequoted dictum of Lord Diplock is the locus
classicus on the subject and succinctly explains what is meant by the tort
of passing off.

Therefore, it may be noted that in order to enable the owner
of a trademark to sue for passing off, he would be required to show in the first
instance that the trademark is associated by members of the trade and public
solely and exclusively with the services rendered and/or goods sold by him and
that some other person by using an identical and/or deceptively similar mark in
respect of similar services and/or goods is trying to pass off his goods and/or
services as and for the goods and/or services of the owner. Confusion and
deception in the course of trade would be essential to an action in passing off.

It is common understanding that an action for passing off cannot be instituted in respect of an unused trademark, however the same is incorrect. For in a given situation passing off may even be instituted in respect of a trademark which has not been used in the market, but which has acquired reputation and goodwill on the basis of other factors such as publicity, advertisements, etc. and has therefore, come to be associated solely with the owner of the trademark.5

Distinction :

The distinction between an infringement action and a passing off action is important. As explained above, both operate in different spheres. Hence, to illustrate there could even be a situation where a registered proprietor (Plaintiff) files a suit for infringement and the defendant files a suit for passing off against the same plaintiff. This would happen in a case the defendant has a prior user of the trademark but a subsequent registration.

The issues involved in an action for infringement and an action for passing off are different and distinct. In an action for infringement the basic issue would generally be whether the registered trademark and the infringing mark are identical and/or deceptively similar and whether or not they are being used in respect of similar goods and/or services. However, in an action for passing off, in the first instance the plaintiff would have to show that the said trademark is associated solely and exclusively with his services and/or goods and that use by the defendant of such mark would cause confusion and/or deception in the course of trade and thereby people would end up buying and/or procuring the goods and/or services of the defendant thinking they were of the plaintiff. Such acts would cause wrongful loss and harm to the plaintiff.

The Supreme Court has succinctly highlighted major differences between the two remedies and the approaches involved in an action for infringement and an action for passing of in the landmark judgment of Ruston Hornsby v. Zamindara Engineering, AIR 1970 SC 1649, wherein it has laid down, inter alia, as under :

“It very often happens that although the defendant is not using the trademark of the plaintiff, the get-up of the defendant’s goods may be so much like the plaintiff’s that a clear case of passing off would be proved. It is on the contrary conceivable that although the defendant may be using the plaintiff’s mark, the get-up of the defendant’s goods may be so different from the get-up of the plaintiffs goods and the prices also may be so different that there would be no probability of deception of the public. Nevertheless, in an action on the trademark, that is to say, in an infringement action, an injunction would issue as soon as it is proved that the defendant is improperly using the plaintiff’s mark.

The action for infringement is a statutory right. . . . .
On the other hand the gist of a passing off action is that A is not entitled to represent his goods as the goods of B, but it is not necessary for B to prove that A did this knowingly or with any intent to deceive. It is enough that the get-up of B’s goods has become distinctive of them and that there is a probability of confusion between them and the goods of A. No case of actual deception, nor any actual damage need be proved.”

Another important factor of distinction is the fact that under the Act, a registered proprietor is granted an additional right to institute an action for infringement of trademark where the plaintiff’s office is situate. This provision was introduced to enable the registered proprietors take appropriate proceedings against infringers without having to follow them to every corner of the country. On the other hand, however, passing off being a common law remedy, the jurisdiction of a Court to take cognizance of the same would be in accordance with the normal rules of jurisdiction as laid down in the Code of Civil Procedure, 1908 and/or the relevant Letters Patent i.e., either where the defendant resides or carries on business or where the cause of action has arisen, etc.

To illustrate the above points of distinction, take a situation where a trader in pens is the registered proprietor of a trademark ‘KODAK’ (word per se) and has been using the same for the last decade on a yellow and red background in respect of his pens. The defendant is using the trademark ‘TODAT’ in respect of his pens on a white and green background. In such a case for the purposes of an infringement action the Court would only consider whether the trademarks KODAK and TODAT are identical and/ or deceptively similar, since the goods are identical. On the other hand, for the purposes of an action of passing off, the Court would have to consider the entirety of the package including the difference in colour schemes, nature of consumers, packaging, etc. and consider whether on an appraisal of the entire evidence it can be proved that the consumers would be confused and/or deceived into buying the pens of the defendant on the belief that they were somehow connected with the plaintiffs.

In the aforesaid illustration let us assume that the pens are sold by both traders on a red and yellow background but the trademarks involved are the registered trademark KODAK (word per se) and the unregistered trademark PILOT. In such a case even though the trademarks per se are different, an action in passing off may still lie if by colour scheme, packaging, trademark being written in small letters, etc. the consumer and general public would be confused and/or deceived into buying the defendants pens on the belief that they emanate from the plaintiff.

A perusal of the above would evince the fact that the two wrongs are different. Therefore, it is essential for owners of trademarks to understand that even if their trademark is not registered, they may still maintain an action in passing off. In fact, in a given case a trader who may not have used the trademark in the Indian market, but whose trademark has acquired a transborder reputation in India may maintain an action in passing off. A situation may also arise where even if a trademark is registered, use of the same may be restrained by a prior user of the trademark.

Therefore, there can be no general answer as to which proceeding is better and/or preferred and the course of action and must be determined on a case-by-case basis.

Nirav Shah

Financial black holes : Financial Misstatements

SAP

Accounts manipulation is the deliberate misreporting or
concealment of facts in order to create profit or loss in the current period; to
defer profit or loss to a subsequent period; or to misreport performance
statistics and management information. Under both the common and the statutory
law, this is treated as fraudulent activity. In case of deliberate misreporting,
the possibility of repetition of the event is higher, since they are intentional
and for a specific fraudulent purpose. In such a situation, the organisation in
question needs to be more vigilant and stringent with their policies as well as
people. It is, however, important to recognise that financial misstatement can
also happen because of error or systematic problems. In either case, it can
leave an organisation exposed to both the market forces and the regulatory
challenges.

In this article, I have set out some danger signs to look for
and provide an overview of actions to consider in the event that such misconduct
is discovered. I hope this helps to ensure that the ‘modesty’ of many
organisations continues to be preserved.

The potential impact :

The shockwaves caused by accounts manipulation can be severe
and invariably spread far wider than the organisation concerned; the sector as a
whole may be affected or at a larger level, the economy may be hit as well. The
demise of Enron is an obvious example. Another case in point is Satyam, where
the stakeholders are shocked at the size as well as the duration of time for
which the fraud went unnoticed.

The discovery of accounts manipulation will inevitably have a
far-reaching impact, even if it has not caused the victim organisation an actual
cash loss. Loss of reputation is a bigger loss than cash loss, as this loss is
not quantifiable and has far-reaching effects on the organisation as a whole.
The management will be distracted from effective operational stewardship; time
and focus will be lost as they seek to determine the facts of the manipulation,
and then develop and execute a communication and remediation strategy with
various stakeholders. Management credibility is also likely to suffer, the event
has come to light ‘on their watch’ irrespective of where the blame actually lies
— a robust response is a good start in this battle (the related elements are
discussed further
below).

Stakeholders in the outcome of any investigation and
remediation are numerous, and will include the organisation’s lenders and
shareholders and may also include regulators and law enforcement agencies. Any
restatement of the financial statements may lead to, or indicate, lending
covenants being breached, with the consequence that finance lines are withdrawn
or renegotiated. In the current lending environment, this is to be taken very
seriously. Shareholders, especially ‘active’ or institutional investors, may
take the view that their investment decisions have been taken on the basis of
misleading information and commence court action. The potential for the share
price to suffer is also high.

The cost and impact of regulatory and law enforcement
involvement is also significant due to the need to involve external lawyers and
accountants. This is especially relevant if the organisation is a listed entity.
Not only will the share price fall, but it will also adversely affect the
capability of the organisation to raise further capital from public in future.
Even non-listed companies would be adversely affected in terms of their future
listing capabilities. Individual management, the staff as well as the
organisation itself may be targets, with criminal as well as civil sanctions
available.

One impact that is often given less consideration is that the
perpetrators may be in senior positions in the organisation. Through their
dismissal, the
organisation may suffer a shortage of skills or experience, with a likely period
of flux as their replacements bed down into their new roles.

Drivers, risk areas and red flags :

What then, are the indicators that one should be vigilant
for ? In this section, I will examine three areas : the organisational factors
that could put an organisation at risk; the areas within financial statements
that are vulnerable to manipulation; and the signs that something may already be
wrong.

Drivers :

Many cases of accounts manipulation have their roots in
organisational change within the victim organisation. Many organisations choose
decentralisation as a key strategy and encourage the staff to be more
competitive and entrepreneurial. Normally, the empowered local management team
is rewarded on performance, particularly by reference to profitability and the
achievement of budgets. The stakes are also rising, with many more layers of
management now receiving a material proportion of pay linked to performance
targets. Decentralisation can often be accompanied by much of the control
function at head office being removed; as well as division of profile leading to
specialisation. This will result in the lessons learnt in one part of a business
being no longer
effectively communicated across the business as
a whole. Not surprisingly, this combination can make an organisation vulnerable
to accounts
manipulation.

Where accounts manipulation has been orchestrated by the
senior group management and
key management personnel, it can be difficult to detect and investigate, often
involving
either the collusion of a number of senior staff or a very dominant personality
who commands fear within the organisation. The organisation’s
control environment is also a vital factor : it is likely to be weak; or, in the
case of senior
management orchestration, capable of being overridden and window dress the
financial statements. Fraud motivation at this level can be
varied, and is usually more complex than simply financial gain.

Risk areas :

Experience gained through assisting clients, as well as my
observations of other reported events has shown that certain items within the
financial statements are especially prone to manipulation. These, together with
the forms that the manipulation can take, are illustrated in the figure below :

(An illustrative list only)

Red flags :

Warning signs are usually present in the financial
information of a subsidiary, division, joint venture or a group; and, can
sometimes be painfully obvious with hindsight. While the precise signs are
dependent on the sector or industry in which the organisation operates, I have
highlighted a few generic indicators as shown below : (an illustrative list
only)

‘Red Flags’ — A few Classic Examples

Reported results are consistently in line with the budget. This may be accompanied by soft accruals to align the actuals with the budget

Areas of low scrutiny or lack of clarity of accountability for some costs, often accompanied by a failure to perform reconciliations or maintain adequate control accounts

Items within the profit and loss account are based on judgment rather than hard data

High levels of manual journals and accruals without automatic adjustment

Unusual fluctuations in sales or forward purchase orders, particularly around the year end

Revenue and profit trends appear inconsistent with other known information

Profits do not appear to be converted into cash
Poor quality or patchy management accounts, which typically comprise only a profit and loss account

Undue concern about audit visits

Employees feeling of lack of job security in the organisation without proper reasoning from the higher management

No proper basis regarding the provisions made in the financial statements.

Auditors’ responsibility for fraud detection?: Stakeholders of the companies and the general public rely on the auditors for unearthing indications of financial statement fraud. We have observed in recent times how the competencies of the auditors have been questioned for not being able to detect the signals of fraud early enough. Although audit is not a fact-finding exercise, but rather a review of the financial statements, yet it is possible to detect the warning signals by adopting appropriate procedures. Some of these are discussed below?:

Professional Skepticism?: Auditors need to overcome some natural tendencies — such as over reliance on client representations — and approach the audit with a skeptical attitude and questioning mind. They should set aside past relationships and not assume that all clients will be totally transparent.

Discussion among engagement personnel?: Extensive brainstorming among the engagement teams at different stages of the engagement about the client’s susceptibility to fraud will help to identify the critical areas for audit.

Identification and assessment of fraud risk?: Identify the fraud risk and perform an assessment of the identified risks to determine where the client is most vulnerable to material misstatement due to fraud, the types of frauds that are most likely to occur and how those material misstatements are likely to be concealed.

Developing audit procedures to mitigate the identified fraud risks?: The key to designing effective audit tests is to perform an effective synthesis of the identified risks. Appropriate procedures should be developed so as to detect any indication of fraud.

Considering client’s anti-fraud programmes and controls?: Review client’s anti-fraud programmes and controls that mitigate or exacerbate the identified risks of material misstatement due to fraud. Such review will help the auditor to identify potential control weaknesses.

Risk of management override of internal controls?: Auditor should be aware of the fact that executives can perpetrate financial reporting frauds by overriding established control procedures and recording unauthorised or inappropriate journal entries or other post-closing modifications (for example, consolidating adjustments or reclassifications). To address such situations, auditor should test the appropriateness of journal entries recorded in the general ledger and other adjustments.

Retrospective review of accounting estimates?: Accounting estimates are particularly vulnerable to manipulation, because they depend heavily on judgement and the quality of the underlying assumptions. Auditors should perform a retrospective review of prior-year accounting estimates for the purpose of identifying bias in management’s assumptions underlying the estimates.

Business rationale for significant unusual transactions?: Many financial reporting frauds have been perpetrated or concealed by using unusual transactions that are outside the normal course of business. Auditor should use his knowledge about the client and the industry to recognise any unusual transactions. Auditor should then obtain appropriate business rationale for such unusual transactions.

Evaluating audit evidence?: Auditor should evaluate the evidence gathered through analytical and substantive procedures to assess whether such evidence indicate any indication of misstatement that was not considered earlier.

Last but not the least, the auditor should demonstrate highest standard of professional integrity and must be independent not only in spirit, but must also appear as independent to all reasonable persons.

How to respond effectively??

Corporate Governance may be defined as ‘A set of systems, processes and principles which ensure that a company is governed in the best interest of all stakeholders.’

It ensures commitment to values and ethical conduct of a business, transparency in business transactions, statutory and legal compliance, adequate disclosures and effective decision-making with a view to achieving corporate objectives.

Clause 49 of the SEBI guidelines on Corporate Governance (which came into effect from 31st December 2005) has made major changes in the definition of independent directors, strengthening the responsibilities of audit committees and improving the quality of financial disclosures, including those relating to related-party transactions and proceeds from public/rights/preferential issues, which call for CEO/CFO certification, the adoption of a formal code of conduct by the Boards and the improvement of disclosures to shareholders. Certain non-mandatory clauses like a whistle-blower policy and the restriction of the term of independent directors have also been included.

According to the Internet, the revised version of Clause 49 has come into effect since 1st Jan. 2006.

In the event that an instance of accounts manipulation is uncovered, it is imperative that the organisation responds both effectively and robustly. A dedicated committee (containing requisite financial expertise) should be considered to oversee the response. Convening such a body not only enables the management to remain operationally focussed, but also ensures that the response is independently managed and free of any perception of conflict of interest.

The committee should aim at rapidly mobilising an investigation team to identify the root cause and quantum of the problem. This will help determine the immediate measures that will need to be taken to mitigate the impact on the business and should also assist in a complete identification of stakeholders.

The latter exercise will enable the reporting and ongoing communication needs of each issue to be assessed and a strategy to be developed. The importance of a credible engagement with the stakeholders at the earliest opportunity cannot be underestimated.

The next stage is to consider whether and to what extent the organisation wishes to utilise external professional advisors. Often, forensic accountants and lawyers are key resources who can contribute with their rich experience and perspective from previous investigations, as well as strategic and investigative input, including assistance with the capture of data to the standards required by regulators or the courts.

Ensuring that the relevant hard and soft copy data is gathered in an evidentially sound manner is a vital element of the response. This will require some preliminary consideration of the accounts affected — for example, customer and supplier details may be kept in a different module from financial statement data. An organisational chart will help identify individuals who process and manage data in the affected area. This will inform the custodians about which employee data needs to be analysed. The organisation should also consider issuing a data preservation notice to all relevant employees.

Conclusion?:

Economic indicators suggest that the current climate is likely to persist for the next couple of years. It is challenging in a business context, both in terms of the trickling effect from the recession in the US and current lack of resources. At the same time, the costs of inputs have been rising. Organisations continue to be under pressure to produce growth and returns for shareholders and to comply with lenders’ covenants. This environment may provide a stimulus for accounts manipulation to take place and organisations would be well advised to be vigilant.

Nirav Shah

Some thoughts on working late

LIGHT ELEMENTS

The President of the Society had in his column in the March
2010 issue of the BCA Journal, brought the attention of readers to some of the
rare qualities of CA Aditya Puri (the Managing Director of HDFC Bank who had
recently won a prestigious award), particularly his time management skills which
help him to leave his office every day at 5.30 p.m. The President had requested
readers to apply their thought on that aspect, considering the fact that
Chartered Accountants — both in practice and in employment — are generally prone
to working late. Taking the cue, the author tries in a lighter vein to analyse
the culture of working late which has now spread to almost all sectors of
commercial activity in the country.

Globalisation has brought many things to India, and working
late is one among them. Not that we Indians are not used to late working hours.
We do work late when need arises. What is new is the culture of regularly and
compulsively working into the late hours of night. Those working in today’s
so-called sunrise sectors are always seen working well past sunset. For them
apparently the sun only rises, it never sets.

Some are sceptical — and sometimes even a bit suspicious — of
people working late. Probably they carry such thoughts out of their past
experiences. When there are different views on the virtues and weaknesses (not
necessarily vices !) of working late, it will be good examining the different
aspects of late working.

The common impression that a person working late — or an
organisation that encourages employees working late — conveys is that they are
so busy and overloaded with work that they cannot complete their work without
putting in longer hours. But on closer scrutiny one often finds that this is not
true. Organisations which follow the modern (read American) management-style
employ less people than what is required, so that they can pay higher
remuneration to employees without increasing their total wage bill. As a result,
their limited number of employees are forced to slog it out. It is with this
aspect in mind that management schools train their students to study and work in
sleep-deprived environment without losing their senses. Most business
enterprises are not bothered by studies that show that deprivation of sleep
adversely affects the productivity of employees.

Even in the modern business organisation where the office is
always open late into the night, and all employees are present, it is
questionable whether everyone is actually working. When employees working in
frontline IT companies say that everyday they work from 8 a.m. to 11 p.m. and so
on, one is naturally a bit curious. If one asks an employee, in confidence, what
exactly is the work that is done late into the night one can expect a reply
somewhat like this : “I actually work for 3 or 4 hours maximum. The rest of the
time I am awaiting my senior’s instruction to start working with him. My senior
is always doing something unrelated to work, and mostly roaming around.
Everyday, right from morning, I ask him at intervals of a couple of hours ‘Shall
we start ?’, but every time he replies, ‘No, wait’. Finally, by 8 p.m. or so, he
asks me to join him, and we start working. No wonder we will reach somewhere
only by 11 p.m.” This is found to be the case with many people working in the
so-called emerging businesses. The blogs of employees in the Internet too
confirm this.

Even if it is not the policy of an organisation to make every
employee regularly work overtime, employees do sit up late for different
reasons. The obvious reason is to impress the bosses. But there are less obvious
reasons too.

For some habitual late workers — whether employed or
self-employed — their work-place is not their ‘second home’ but ‘first home’
itself. These unfortunate guys do not get peace of mind in their homes for some
reason, and so they remain in offices as long as possible to minimise time spent
at home. What they do at their offices in the after-hours is anyone’s guess —
chatting with friends on or off phone or net, partying (with or without booze),
reading and sending out unnecessary emails, browsing the net or taking a nap. If
possible, they encourage lot of visitors to their offices after office-hours,
thus converting the office into some kind of a club. Some carry the idea of
‘home’ to such an extent that they actually have a bed too in their offices. In
such cases, the public cannot be blamed for suspecting something.

The accounting profession is famous for continuing to work
after everyone else has gone home. But accountants working late are sometimes
viewed with suspicion too. There is the story of a chief accountant in an
organisation who was working well past midnight everyday. The accounts were,
however, very much in arrears. The late sitting was also justification for the
accountant to come late — by late afternoon — everyday. He thus reached the
office when everyone was preparing to leave, and he was working all alone
(presumably) all through night. When there was a change of management, he was
told to follow regular working hours, and an inquiry was made into the accounts
being maintained by him. As skeletons started falling from every cupboard, the
chief accountant was fired.

To be fair to those working late, all of them must not be
equated with the accountant in the above story. Not everyone is doing illegal or
unnecessary things — or entertaining themselves — while burning midnight oil.
One of the reasons is that not everyone is competent enough to handle different
types of work during normal working hours. Many bank managers, for instance,
cannot gather the mental concentration required to scrutinise loan applications
or monitor their non-performing parties during normal hours when they are
attending to customers. They therefore sit up late to do those jobs. Such
employees deserve sympathy, not scorn.

Some others overburden themselves, as they do not delegate
work. For many in this category, the problem is that they do not trust any of
their subordinates. For some others, it is a way of making themselves
indispensable. They follow the age old maxim : ‘Keep things pending, so that the
pending will keep you’.

At the other extreme there are those who do not trust themselves but trust their juniors completely. They delegate all their work and go about doing practically nothing. They will, nevertheless, be present in office until everyone leaves so that their enviable style of working will always remain a best kept secret. How do they kill their abundantly surplus time?? They devise all sorts of ingenious methods. Presiding over or participating in endless meetings is a time-tested trick. Meetings are now referred to as training sessions, presentations, seminars, workshops and so on. Whatever the nomenclature, they serve the purpose of the wandering late worker by consuming his surplus time. The worst part of these workshops is that they take away a lot of time of the productive employees too. Sometimes, to keep the subordinates engaged, the inefficient senior makes them do dummy projects without saying so, or ask them to submit several lengthy reports on work already done.

In today’s IT-enabled environment, working late within one’s office is not always necessary. For the Chief Executive and other senior executives, there is no such thing as ‘working hours’ as they have to be available on call on a 24/7 basis. In the case of the lower-rung executive too, he can work from home or anywhere else — while on the move too. Even team assignments can now be carried out by persons sitting at different places. That being the environment now, regularly working late in one’s seat in office has become practically unnecessary. Not surprisingly, a few organisations have started discouraging late working — disabling computer servers, ordering closure of offices and switching off of mains at a specific time to push out die-hard late sitters.

Having thought of some of the aspects of late working one can only warn both individuals who work late, and organisations that encourage employees working late, to determine whether the late working is really necessary, productive and economical. If it is not, then trying to merely create an image through late working will not be rewarding in the long run.

Nirav Shah

CFO — the new horizon

CFO

Introduction :

Organisations in the recent years are struggling to withstand
pressures from various quarters like compliance, auditors, capital markets,
shareholders and so on. These are over and above the usual day-to-day business
pressures. Take the case of US companies. The southward-moving economies,
mounting oil prices, falling currency, and increasing cost pressures have
already put US managements under tremendous stress. To top it, the hanging sword
of SOX coupled with obsessed auditors is making every quarter a strained
experience for the whole organisation.

Noticeably Chief Financial Officer — CFO — is at the centre
of all this stress and strain. The expectations from the CFO have undergone a
sea change in the last decade. While internal expectations are at the same
intensity, the external pressures from regulators and capital markets are
growing day by day and quarter by quarter. Just beyond crunching numbers, all
these internal and external stakeholders expect a CFO to deliver lot more value
for the organisation. While these dynamics are changing dramatically, the CFOs
have to handle their own financial organisations, who like other parts of the
business, resist any changes that are needed to face these pressures and
challenges. Looking at the various global organisations, I feel, the success of
the CFOs lies in how they handle these external and internal expectations and
how do they bring about the transformation within their own financial
organisations to cope with these changes.

Obviously, this means that the business requires not only a
competent leader heading the finance function, but also a competitive leader to
lead the business activities. The finance organisation is uniquely positioned to
direct some of the uncomfortable activities that the current regulatory and
external stakeholders expect because otherwise no one will do them.

Value creation :

In the given era, the business, externally and internally
expects the CFO to create huge and unique value for the company. The value, as
widely understood, gets created by having effective capital structure, setting
expectations for the investors, setting stretch goals for revenues and
profitability, so that the business meets its all long-term aspirations.
However, this happens not only under dynamic but sometimes volatile
circumstances.

The decisions on capital structure in the past used to be
long-term decisions. But in the given era, with globalisation and capital and
debt markets becoming smart and open, one has to keep a constant check on the
optimisation of capital structure. In a country like India where the laws reduce
the flexibility of such decisions (like buyback and issue of own equity, etc.),
the role of CFO gets tougher as the competition faced is of a global nature.
Thus in given constraints and framework the CFO has to perform more skillful and
non-standard financial engineering models to ensure that the business gets
optimum capital structure at all the times.

The same situation is faced on managing investors’
expectations. The capital markets around the world are coming closer and the
investors’ expectations are becoming almost similar from a business in the USA
and the one from India. The investors, if are giving higher multiple to your
company than a similar one in the USA or Europe, they have to be convinced about
the reason for such higher valuation of your business.

This brings the growth story. In IT industry, or now I would
now name it as Knowledge Industry (KI), the 30% growth story is impressive all
along to the global FIs, but to sustain these growth numbers at a billion $ +
top lines is a different challenge that no CFOs in India had faced before. The
CFOs are expected to create these values.

While doing that role, internally, the CFO has to maintain an
effective rhythm in the business thru participation in business planning and
review sessions. During this process, the CFO has to expose the areas of
underperformance in the business to ensure that overall growth and value do not
have a drag. This requires a lot of political and tactical skills. Weeding out
the dead log from the organisation in the current era is very critical and
crucial for survival of the organisation and the CFO has a lot of value to add
in this area.

Creating competitive edge :

As I said earlier, in the given volatile situation of the
markets and economy, every CFO has to ensure that the finance organisation that
he or she leads, has to have competent people that will give the business
competitive advantage. This needs attracting and retaining people with excellent
financial skills who are good at numbers and also technically sound. With all
kinds of GAAPs and clarifications and commentaries coming on such principles,
the CFO’s life has become more complicated. The hand-tied auditors and audit
committees add more complexities by their indecisiveness and tendency of keeping
themselves guarded in any eventuality. The CFO is truly trapped within business
objectives, regulatory interpretations and illusive shackles created by others.

This needs the CFO to benchmark each of the finance function
constantly. The basic benchmarks should be on performance on delivering
reasonable and adequate returns on capital deployed to the stakeholders.
Unfortunately, there are only few metrics available today to judge and measure
the quality and competency of finance personnel. Still, one has to form its own
metrics for the quality of the people in the finance organisation. As CFO, I
would always see if my people are in demand in the market. If one of the senior
persons leaves and joins as a CFO of another company at double the salary, I
take it as a benchmarking exercise of the quality of my people. They must be
good if one of them goes as a CFO of another organisation at double the pay !

Another way to judge the quality of output is to encourage people to participate in awards. Say, Institute of Chartered Accountants’ award for best-presented annual report. Such competitions provide an urge to improve quality of the output like annual report of the company.

Highest integrity of each finance team member is also one of the critical factors to achieve competitive edge. In the current environment, it is important that there should be zero tolerance for non-compliance. Controls are not only needed in substance but also in form. For example, if you have internal review meetings, the minutes of the same need to be recorded and circulated, action items must be tracked and completed to ensure that all the adequate controls are in place and are followed adequately.

No surprises:

This is the dream that every CFO has and wants to achieve. Business and markets give you enough surprises. What you hate to have is more surprises coming from your own organisation, from auditors and from the audit committee. Thus constant liaison with auditors and the audit committee has no substitute. Every non-business as usual (BAU) matter must be informed to these entities immediately to avoid last minute surprises to either side. This ensures a healthy relationship between all the stakeholders !

Internally, anticipating issues before they arise is essential. The CFO must have a list of peculiar transactions that may give rise to any non-BAU issues. Such issues need to be attacked on a war footing in time to avoid the quarter-end surprises. If you have number of subs in multiple countries reporting their numbers in different currencies and GAAPs, your responsibility goes up multifold as each of such sub, its GAAP and reporting currency has many surprises stored at the time of consolidation. The interpretation of GAAP provisions and their respective treatments in books can vary so much that quarter-end consolidation can become truly a nightmare! This requires a tight forecasting schedule and ability of the business to forecast accurately. In spite of spending hours on calls with the business people on forecast numbers, outlooks and budgets almost every week, there is a huge scope for a surprise and one has to have a plan to deal with such situations wisely and sometimes bravely. Revenue recognition or impairment of intangibles or compensated leave provision are some of the areas that can give last-minute surprises in US GAAP. Foreign Exchange Accounting has its inheritant element of surprise on the last date of a quarter. The CFO has to learn to pass thru these situations.

Complex life:
While the CFO is busy adding value to business and creating competitive advantage to the business and avoiding surprises, the ever-changing laws and demanding auditors and audit committees (especially those coming under laws like SOX !) makes life of the CFO and his organisation more complex. Indian companies are going global, and preparing accounts with different reporting currencies, different GAAPs, consolidations under Indian GAAP and also mostly US GAAP, and lastly every quarter with ‘deadlines’, Most of my CFO friends truly experience the meaning of ‘Dead’ line! Truly, life has become too complex.

I think it is time to question what is the value of publishing the quarterly numbers. Modern businesses are too complex to be evaluated on just one-quarter numbers and get in to enormous discussions on QoQ and YoY numbers, LTM numbers and so on. Other than audit firms and TV business channels and media, no one (especially investors/shareholders) stands benefited! It loses quality and adds complexity of numbers at the heavy cost of health of finance/accounts organisation of each listed company. Further, we add to our complexity by giving guidance for the next quarter and try to achieve it or beat it with no regards to global market dynamics (not capital markets) of our own Industry.

I think all of us bring of the same fraternity should make a serious attempt, to see that we get a stable set of GAAP rules which do not have multiple interpretations, leave some space for the CFOs’ integrity and discretion, rather than asking auditors to interpret GAAP rules (AS) (as if they are Vedas and only the auditors have right to interpret them! !); stop this quarterly business and make it half-yearly and move as early to IFRS to have common rules for global subs and consolidations of accounts. There are number of areas where the same transaction gets treated differently in different parts of the world. Even OECD countries do not have common understanding of the accounting treatment of similar transactions. Compensated leave, intagibles, ESOP accounting are some of such areas. IFRS, I believe, will bring these complexities and confusions to an end. In the USA, number of multinationals have found a solution otherwise! They have started publishing ‘Non-GAAP’ numbers with a management statement that these numbers are not audited but the management feels that they represent ‘true picture’ of the business !

The problem that I see is, in all this intellectual exercises and professional egos, all of us have forgotten that the main purpose of the reporting is to elucidate the current shareholders and prospective investors about the affairs of the company and allow them to have more educated judgment on the future performance of the company they have invested in or want to invest. In the bargain, not only have we made our lives complicated, but also made these numbers almost indecipherable to all stakeholders.

I feel, this is not impossible, though difficult.What we need is to put brains of professional accountants, CFOs, and regulators together to see how we ultimately help to create a value for our business, how we bring competitive advantage to our business without making life unnecessarily complex by bringing some common standards and compatible accounting practices that give all global stakeholders some same and meaningful information at reasonable intervals. I can only hope, we will reach there one day and it may not be just Utopia!

Nirav Shah

Chartered Accountants in the 21st Century

Chartered Accountants in the 21st Century“It’s not the strongest of the
species that survive, nor the most intelligent, but those most responsive to
change”

The 21st century will be unique as we will see the balance of
economic power shift to Asia from the western world which has dominated the
previous 400 years. With India and China growing at over 9%, for the first time
in human history, we will see 40% of the world population experiencing growth at
this level with multiple ramifications in every sphere. Asia will also reap the
benefits of a demographic transition as it has a very young population, with
lesser dependence, growing in a high-growth ecosystem. At the same time, the
developed world is seeing the rise of an ageing population, with increased
dependence and social security costs.

Advances in technology, creation of the World Wide Web,
massive reduction in costs of telecommunications and the democratisation of
travel is creating linkages, totally shaking up national markets. Transnational
flow of capital has reduced the ability of nations to control their currency and
their own economy, creating an interdependence never seen before. Free flow of
capital has led to the rise of giant transnationals, which today make up 60% of
global trade and command huge resources. Because of the wide diversity of
ownership and business, the world has become much smaller than we can imagine.
Cross-border movement of national persons is creating new risks and new
opportunities. In a world driven by innovation, the only true competitive
advantage would be the capability and talent of the human resources that every
nation or business entity can command.

The global economy is being driven by the knowledge
revolution. Knowledge transcends boundaries, while businesses transform from
being multinational to transnational. The world has now become a global village.
Collaboration, networking, mergers, consolidation, and partnerships, all are
creating an interdependent world.

In this knowledge era, our success depends on what we know
and what we do with what we know and in what we need to excel. Those who are
able to take advantage of these changes will pioneer the creation of wealth and
the advent of new business models.

Changing Indian scenario :

So, welcome to change and welcome to growth.

India has led this change globally, growing at 9% p.a. for
the last four years. The rapidity of the change, and the opportunities that it
has thrown up, has tremendously increased opportunities for every profession and
also created a global market for services. The demand for Chartered Accountants
(CA) both in the profession and in industry has led to shortages with massive
increases in compensation. The profession needs to reflect on the opportunities
and take full advantage of growth. Because of the global nature of the change,
one also needs to scan the globe for trends and prepare oneself in terms of
increasing competence levels.

Industry is in need of complex specialised services and is
being forced to look elsewhere and this is becoming a matter of concern. The
growth of the BPO/KPO sector providing global services, has brought in massive
use of technology to deliver services and over a period of time created a large
pool of talent, unheard of anywhere else. In the short run, this has led to a
severe shortage of talent and large increases in compensation, creating room for
other professionals to run in. Professional practice is suffering with over 85%
of new members joining industry and large-scale flow of talent out of the
system. This, along with the increased demand from industry would lead to
consolidation of practices and reshape the profession. Small enterprises are
deprived of the services of CAs, impeding their growth, calling for new policy
responses. Welcome to the 21st century.

CAs are also becoming CEOs of local and transnational
enterprises, creating role models of the future.

The Chartered Accountant is India’s best known and most
widely respected professional. It represents years of business studies, work
experience, and the highest standards of professional ethics and objectivity.
But it is based on the model of yesterday and needs to reshape to meet the needs
of tomorrow. It should not be a profession of historic glory, but rather should
write its own history in this new era.

Role of CA :

Because of globalisation CAs are providing specialised
services in all areas that their global compatriots in developed nations
deliver, such as International Accounting, International Taxation, Business
Valuation, Cross-border structuring and Mergers and Acquisition, Investment
analysis, etc.

Some areas which are in great demand are discussed below.

(1) Financial Analysis :

Analysis of routine and non-routine transactions and
preparing analyst’s reports for various equity research firms, provide inputs
for the credit rating agencies, creating the basis for merger/business
combination decisions, etc.

CAs having a sound financial knowledge and analytics, and a
deep understanding of generally accepted accounting principles, are able to
comprehend transactions including benchmarking the policies adopted by the
company against the best in industry.

(2) International Tax and Domestic Management :

As companies globalise rapidly, demand for international tax
services and use of DTT’s is growing multifold. Domain expertise in
international tax laws is becoming a hygiene factor. Such services are becoming
the basis of determining business outcome in firms and have moved away from
playing the role of a traditional interface. Specialisation in complex areas
such as Transfer Pricing is of great value.

In the domestic area, reduction of tax rates and advent of
technology have changed the face of traditional tax planning. With exponential
growth in the services sector, complexities in indirect taxes such as service
tax are on the increase calling for tax strategies to drive business.

(3) Risk Assessment :

Risk management has become the prime focus in Boardrooms round the world. The recent sub-prime crisis has demonstrated the need for more stringent risk management practices and elevated the practitioners to a much higher level. CAs have become reviewers of system design, indentifying deficiencies and advising management on more efficient systems.

International regulations like SOX compliance have opened an area of services, from designing of internal control processes, mapping risks, establishing benchmarks and indentifying processes to mitigate them. Internal Auditors have been empowered through strong corporate governance practices to report directly to the Audit Committee, post-discussion with management, which provide them with the authority together with the responsibility to carry out their functions in the truest sense.

(4) Experts in International Financial Reporting Standards (IFRS):

The world is moving rapidly to a single set of high-quality global standards for accounting, increasing access to capital and enhancing comparability of performance. CAs have to rapidly enhance their expertise in accounting to prepare themselves. The advent of a global IFRS would expand the market for services, with the entire globe being the playfield. Most countries in the world are short of specialised accounting talent and unable to cope with the growth of their economies and are sourcing talent from outside. The transition to a single IFRS globally also creates unprecedented opportunities to our CAs.

(5) Management Accounting:
The drive to use real-time information for business decision-making has exponentially increased demand for management accounting in firms. With the capital markets becoming increasingly short-term and analysts’ attention focussed on quarterly results, this area is expected to grow rapidly in future. Budgeting, performance evaluation, cost management, and asset management to increase returns are creating a pull factor. Management accountants have become part of executive teams involved in strategic planning or development of new products.

(6) International Finance and Currency Management:
With the increasing convertibility of the rupee, firms are borrowing globally to reduce cost of capital and to grow more rapidly. Capital has ceased to become a constraint and exposure to international finance, capital markets and currency management is determining success of CAs. This is also driving the need to have competency in compliance and reporting, as capital is raised from different markets and the regulatory need increases.

(7) Investment Banking and Financial Services:

Investment banking is dominating the financial services landscape. Never has the world seen such a surfeit of capital and such low interest rates. Developed countries are forced to have low interest rates to keep their consumption going, increasing liquidity and thereby opportunities for investment banking. Sadly, the best global talent is gravitating to this area, reducing innovation in the sciences. The growth of hedge funds has increased volatility in the commodities markets, increasing costs for ordinary people. As this industry offers a fascinating and fast-paced growth to CAs, a change in outlook is called for. The traditional financial services area including financial consultancy services, advice and negotiation with regard to mergers and acquisitions, formulation of nursing programmes and rehabilitation packages for revival of sick units is also seeing growth.

(8) Corporate Finance and Control:

Corporate finance and control is fast emerging as a specialised function in many companies and the routine accounting function is being delinked from the finance function. Role of CA in corporate finance revolves around mobilisation and utilisation of financial resources for short-term and long-term purposes from domestic and overseas markets through a proper mix of debt and equity, with the goal of optimising returns. Treasury management has become an integral part of corporate finance.

(9) Investment Management:

With low interest rates and increased liquidity, the capital markets and the money markets have witnessed the introduction of new instruments and intense interplay of demand and supply which have increased the volume of activity. Investors increasingly entrust their funds to mutual funds, creating demand for portfolio managers. A portfolio manager’s job is very challenging since it involves the balancing of risks and rewards through skillful shuffling of the portfolio and maximising the return on investment. With significant growth of the mutual fund industry, the demand for portfolio managers will further escalate.

(10) Functional Specialists and Partners in Information Technology:

Multinational companies with globally dispersed operations require enterprise resource planning (ERP) solutions for optimising their organisational functions. These include designing efficient supply-chain management systems, designing financial systems to obtain information across the organisation seamlessly. A CA with his financial expertise can partner with software engineers in designing and customising these systems to cater to each client’s requirement. This is a high-demand emerging area with global opportunities.

(11) KPO/BPO and ITES :

In a country that has become the breeding ground for the BPO industry, finance and accounts (F&A) outsourcing is fast attracting CAs. While BPOs are cashing in on the Indians’ affinity to numbers, a global work culture, coupled with a much better remuneration, is luring accounts graduates and CAs towards the offshoring wave.

The potential applications of KPOs tend to be much more advanced and wider than Information Technology or Business Process Outsourcing. Compared to other business models, KPOs require high domain expertise. Speed of response is also very important, without compromising the quality of products or services.

The key areas that are outsourced in KPO include business analytics, asset accounting management, financial analysis, payroll management and financial research & investigations. It is evident that there are a number of lucrative opportunities for CAs who are willing to take advantage of this market.

It is worthy of mention that the US has developed an xml-based language for financial reporting language called eXtensible Business Reporting Language (XBRL),which provides a tag with a standardised definition to each data element in the financials. This would also bring in KPa opportunities for India.

The BPO/KPO industry has the potential to create a further shortage of accounting skills in India, as their exposure to the global market makes India the accounting office of the world.

Skills & competencies:

Indian CAs have proven themselves to be amongst the best in the class globally. The Institute has developed a Competency Framework to map the full range of competencies expected of a Chartered Accountant at the point of admission to membership.

CA Competencies = Skills + Knowledge + Attitudes

These competencies have been developed by Indian CA profession over many years and have recently been revised to reflect the needs of the public and the profession for the 21st century.

The CA Competency Map defines the level proficiency candidates must demonstrate in each of the competency areas to qualify for their designation. The new CA Competency Map sets out specific expectations for CAs in competency areas of specific domain competencies and personal attributes.

CAs cannot stop learning upon obtaining their degree and attaining membership to the profession. The responsibility to deliver and keep one-self competent to deliver starts from that day. Their responsibilities include :

(1) Being innovative:

In today’s world knowledge is power. Success will go to those who survive downturns through constant innovation. Hence, the learning process will have to be continuous. CAs have to ensure effective continuous professional learning.

(2) The power of technology:

Adopting newer technology is a pre-requisite to faster and accurate processing. A CA cannot afford to waste time in performing mundane functions as such businesses are looming under the threat of obsolescence. With the e-revolution in the financial sector, audits have gone online, internal controls are being tested off-site, desk-top due diligence is being done and thus the profession has to evolve new strategies for analysing the potential weakness in each of these systems for tackling many of the white-collar crimes that could be part of an automated society.

(3) Specialisation :

Specialisation is the need of the hour. CAs will have to distinguish themselves with their skills. They can build their expertise in areas such as taxation, auditing, cyber laws, IS audit, corporate finance, international taxation and international accounting standards.

(4) Building soft skills:

Acquiring soft skills such as communication skills, interpersonal skills and managerial expertise has become very critical for being a good CA. CAs need to have good negotiation skills to communicate financial implications with clarity at strategic t level.

(5) Leadership:

New members of the profession are the leaders of tomorrow. They need to groom themselves to take business decisions and should not restrict themselves to financial areas. They should build themselves as well as the profession towards a truly world-class standard.

Role of ICAI:

ICAI, as the professional body for Indian CAs, would need to reshape its role to playing a more global role in changing the global financial architecture. It has to focus more on preparing its members to the new challenges, take the lead in developing the profession in the emerging markets and participate in global forums to set standards.

Certain areas where ICAl can play a pivotal role in enhancing the quality of members are :

Intensive courses and certifications in the areas of international accounting standards, XBRL, international taxation, business valuation and other specialised areas. These should be conducted by eminent persons in the profession.

Internal activities of ICAI including the project being undertaken should be available on the ICAI website. Minutes of the meeting should be well documented and comments received on draft publications should also be available on the website.

ICAI should encourage exchange programme for members of different countries to share ex-periences and learn from global practices.

Tie-ups should be made with all international bodies for enabling members to access international research materials, publications and global best practices.

Provide executive education courses for non-finance professional in areas of common interest.

Raise sufficient funds for research for matters which are issues faced by a large number of entities.

Involve in extensive collaborations with global corporations for placement with lucrative offers to make this a very covetable profession.

ICAI should enter into reciprocity arrangements with other countries for global acceptance of the degree.

Last but not the least, Indian CAs should be looked upon as the best accounting professionals of the world. To achieve this goal, ICAl has to market its potential in the global markets, convincing global corporations to receive their accounting and au-diting services from India.

Conclusion:

India’s GDP is expected to grow from US $ 1.2 trillion to US $ 2.5 trillion in the next ten years and to US $ 5 trillion by 2028. It is a time of unprecedented growth and opportunity. Every year India itself needs at least 25,000 new chartered accountants and the number will only grow further as the economy grows. The entire globe is looking to India to get the accounting talent to lubricate the global markets. All of us should be prepared for the global markets with skills comparable to the best in the world. CAs have to lead India in this century. Posterity will not judge us kindly if we do not rise to the occasion.

As Peter Drucker once said “One cannot manage change. One can only be ahead of it”.

Nirav Shah

The decade ahead

In the period of more than fifty years that has elapsed since
I qualified as a Chartered Accountant, the only constant has been change.
However, what has not been constant is the rate of change which has been
accelerating at an ever faster rate. More significant developments have taken
place in the world of the accountant in the last decade than in the preceding
four decades and it is reasonable to assume that this rate of change will
accelerate even more in the coming decade.

It is not easy to predict change, but those who do not
anticipate change and plan accordingly, do so at their peril. While we may not
be able to identify the exact nature of the changes which will take place in the
coming decade, it is possible to identify some of the underlying trends which
will cause change and consider their possible consequences.

The first and perhaps the most significant trend is the all
pervasive impact of information technology. IT changes not merely the methods by
which financial information is produced, but can significantly influence the
content of that information, its form and its frequency of presentation, as also
the role of the auditor.

Information technology makes it possible for information to
be produced, analysed and collated very fast and this will generate demands for
financial information to be prepared and presented to shareholders on an
on-line, real-time basis. The annual general-purpose financial statement as now
produced in the form of the annual report may well disappear. In fact we are
very fast reaching the stage where, as a cynic when referring to the annual
report put it, “Analysts do not need it and shareholders don’t read it”.
Electronic filing of myriad statutory reports with regulatory authorities will
also become the order of the day and audit firms will have to increasingly
embrace automation in their auditing processes totally to handle this.

There will be a fundamental shift in the objective of audit.
Arithmetical accuracy of data generated through electronic systems will be taken
for granted and emphasis will shift to the validity of the input data and the
meaningful evaluation of the outputs generated. Higher level skills will
therefore be needed to make the resultant value judgments.

The development of the eXtensible Business Reporting Language
(XBRL) will be greatly accelerated. XBRL assigns a tag to each individual data
item in financial information containing contextual information such as
accounting period, company name, currency of use, etc. This makes it possible to
identify, extract, exchange, manipulate and report data quickly and easily. XBRL
will revolutionise financial reporting by making it possible for anyone who
wants to use financial information to analyse it, re-use it and exchange it in
any desired form. This can improve the transparency of financial statements and
returns filed with regulatory authorities and XBRL filings will become
mandatory. Already in the UK, XBRL filings have been made mandatory for all
corporate tax returns by 2011.

Significant progress has already been made in the development
of XBRL software throughout the world. The International Accounting Standards
Committee Foundation has developed IFRS-GP and software has been developed to
tag companies’ reported data and to validate the accuracy of self-tags for SEC
filings in the US. In India also, the project for XBRL development has been
assigned to a sub-committee of SEBI’s Standing Committee on Disclosure and
Accounting Standards (SCODA).

A second significant trend which can be identified is the
impact of globalisation in general and the development of international
standards of accounting and auditing in particular. India’s emergence as one of
the fastest growing members of the world economy carries with it the necessity
that it should rapidly align its financial systems with international practices.
Adoption of international accounting standards by 2011, as announced, is an
essential step in that direction. However, there are certain
aspects of this decision which need to be considered.

First, there is the oft-repeated complaint that accounting
standards are increasingly becoming too academic and divorced from practical
considerations. It is said that because of this approach, financial outputs are
often at odds with economic reality. It is also claimed that accounting
standards are becoming more complex. That there is merit in this claim is
obvious from the fact that the International Accounting Standards Board (IASB)
itself has recognised the need for reducing complexity in some standards. Thus,
it has recently issued a discussion paper on ‘Reducing complexity in reporting
financial instruments’. This paper argues that the many ways of measuring
financial instruments may be one main cause of complexity and while the
long-term goal should be measuring all types of financial information in the
same way, there will have to be an intermediate approach which must (a) provide
relevant and easily understood information; (b) be consistent with the long-term
measurement objective of fair value; (c) increase the number of financial
instruments measured at fair value; (d) not increase complexity, and (e) be
significant enough to justify the costs of the change.

Second, there is the growing debate between principle-based standards as proposed by IASB and rule-based standards as in US-GAAP. Both carry certain risks. The SEC in the U.S. argues that principle-based standards carry the risk of poor judgments which could be second-guessed by hindsight, whereas rule-based standards provide clarity and ensure risk. However the Enron, Worldcom, etc. debacles clearly show that rule-based standards are not free from risk as they can be easily circum-vented. The more -fundamental objection to rule-based standards, however, is their unsuitability as a basis for international standards. Rule-based standards are derived in the context of the environment in which they are developed and a rule which is appropriate in one jurisdiction may be wholly inappropriate in another jurisdiction with a different environment. In order to develop a single international standard, IASB and FASB are progressing along the road of convergence of IFRS with US-GAAP, but there is increasing concern that what may finally emerge willbe principle-based standards with rules.

But by far the most important area of concern is the growing trend towards ‘fair-value’ accounting in international standards. As a long-term goal, the concept of ‘fair-value’ accounting is unexceptional. It significantly enhances the role of financial information as a tool for making investment decisions and it obviates the ‘movement’ errors which occur when the values of assets and liabilities change over a period of time. However, there are significant difficulties in determining fair value and when fair value is based on estimation and guesswork, ‘measurement’ errors can occur.

IASB has in November 2006 issued a discussion paper titled ‘Fair Value Measurement’ which incorporates a definition of fair value as “the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date”. This borrows the definition used in a standard issued by FASB two months earlier, but the important difference is that whereas the term ‘fair value’ is used restrictively in US-GAAP to cover financial instruments and business combinations, it is used more extensively in IFRS to cover most assets and liabilities.

The big problem is that in practice, and certainly in developing countries like India, there often does not exist a market in which orderly transactions can take place between participants. Therefore ‘fair value’ will have to be estimated by the preparers of financial information and these values would be subject to the significant risk of ‘measurement’ errors, both deliberate and in good faith. Auditors also could become more dependent on managements’ judgment and as Warren Buffet has so aptly put it, marking to market could well become marking to myth.

Globalisation also will have an impact on the regulatory framework of the auditing profession. In the U.S., the Public Company Accounting Oversight Board (PCAOB) established under the Sarbanes-Oxley Act is required to exercise oversight over overseas audit firms which audit U.S. listed companies or their subsidiaries wherever located. PCAOB teams have already started examination of audit firms in India. In a recent interview, the Head of Audit Regulation of the European Commission has said that the Commission is consulting on how to deal with auditors from non-EU jurisdictions – ‘third countries’ – who audit third-country entities listed in EU regulated markets. The question is whether third-country auditors should be subject to registration requirements and over-sight by EU member states or whether reliance could be placed on the third-country audit registration and oversight authorities. Clearly in making that decision, an important consideration will be the level of public oversight in the regulation of the profession and pressure will mount for this oversight to be by a public regulator and not by the Institute.

A third significant trend which can affect the profession is the growing importance of corporate governance and its impact on the role of audit. The failure of major corporations like Enr on , Worldcom, etc. in the U.S., Royal Ahold in the Netherlands, Parmalet in Italy, etc. has highlighted the fact that corporate responsibility is the central issue which business needs to address. While this has resulted in a spate of regulatory pronouncements and statutes whereby policy makers seek assurance that business delivers sustainable and responsible outcomes, it also demands that business policies are supported by accurate and reliable information and the systems, processes and strategies that produce that information and that there is independent assurance in this area. This is a growing concern which will provide both future risk and opportunity for the profession and also re-define the role of audit.

An auditor has two roles, first, to provide assurance regarding the reliability of financial information as the basis of investment decisions, and second, to give an opinion on the stewardship performance of the management. Traditionally the profession has given prominence to the first role and largely ignored the second. However in the changed environment, the roles will reverse. Auditors will be required to increasingly give assurance to shareholders on the ‘stewardship’ aspect rather than on the ‘decision usefulness’ aspect. This will mean that shareholders will want greater information and assurance on the risks and uncertainties that affect numbers in the financial statements arising from subjective judgments by management regarding revenue and cost recognition. Therefore, emphasis will shift from an opinion merely on the true and fair aspects of financial statements to value judgments on the existence and adequacy of controls and the relationship between finance and risk.

Risk management willbecome a major area of concern for managements and consequently for the auditor. He will need to examine and evaluate the methods by which managements identify risk, and devise and administer methods by which risks are controlled, managed and reported. He will no longer be able to avoid responsibility for failure to detect high-level collusive fraud and will need to devise new approaches to deal with it. He will need to be more pro-active, that is, identify work which is needed and do it before being asked to and will need to ensure that the work he does is relevant and valuable to the client. Managements will also have to accept greater Corporate Social Responsibility (CSR) including in areas of sustainable growth and the auditor will need to audit and monitor these initiatives. All of this will mean that auditors will have to possess wider skills, greatly increase their productivity and create multi-disciplinary firms.

A final trend which we need to recognise is the impact of restructuring in the profession. There are two major themes which will inevitably change the structure of the profession. The first is the growing process of consolidation within the profession, and the second, the continued ability of the profession to attract talent.

The decade which has ended has seen a process of consolidation within the profession whereby the Big-8 have become the Big-4 and a second level of international firms have grown significantly in size. In this process, smaller firms have found it difficult to continue independent existence and have scrambled to join the international firms. The growing dominance of these big international firms and particularly the Big-4 has raised concerns of regulators in many countries. In a recent survey of the investor community in the UK, 25% of the respondents were concerned that the lack of competition could be risking audit quality. However, a third of the same respondents also said that if there was a switch away from a Big-4 firm, they would review their investment decisions.

There have been demands for regulation to restrict this dominance, but clearly that is not the answer. The solution appears to be for second-tier firms to consolidate into larger entities and offer meaningful competition to the Big-4. To create this ‘reputational competition’ they need a better understanding of what constitutes a ‘great firm’. It has been claimed that the outstanding characteristics of a great firm are :- (a) significant sustainable profitable growth; (b) the right type of client base providing the right type of work at the right fees; and (c) the ability to attract and retain quality people. It is also claimed that to acquire these characteristics, these consolidated second-tier firms will need to address certain fundamental issues, namely, (a) the need for a well-planned strategy for the future; (b) acquisition and retention of high-quality staff; (c) leadership at all levels within the firm; (d) concentration on service lines in which the firm excels and avoidance of service lines where it does not; and (e) understanding client expectations and surpassing them.

An equally important aspect is a change in mindset. The profession must give up its dependence on work where it has a protective position and must no longer expect work as a matter of right. Rather it must be willing to sustain its business development through competition, both within and without the profession. Only then will it force itself to take steps to acquire a ‘reputational’ advantage through a track record of first-rate work.

The most crucial factor which will affect the profession’s future will however be its ability to attract and retain talent. With globalisation and a fast growing economy, one of the major constraints for the economy will be the shortage of talent and the resultant competition for it. Institutes in other countries have already addressed this issue and taken proactive action. Thus in the UK, the English Institute introduced some time back a system whereby training for an associate who is not in practice is extended to employers in several countries, including a proposed extension to India. In March 2006, it launched the Pathway Programme which enables professionals with other accountancy qualifications and five years experience also to obtain an associate qualification after passing an ‘examination of experience’. Finally, it has modified its examinations syllabus to enable entrants to take the examination in phases. Many other Institutes may follow this example and the ‘articleship’ system as we know it may no longer remain as the only vehicle for entry into the profession and audit experience may soon become an optional requirement.

If the profession has to address adequately the challenges created by the trends we have identified, the two key drivers which will be needed in the coming decade will be quality and integrity.

The Financial Reporting Council in the UK recently published a paper on ‘Promoting Audit Quality’ and a framework which admirably summarises the key drivers of audit quality. These are (a) culture within the firm; (b) skills and personal qualities of – 1 partners and staff; (c) effectiveness of the audit process; (d) reliability and usefulness of audit reporting; and (e) ability to respond to factors outside the control of auditors affecting audit quality.

Confidence in the auditor’s integrity is fundamental to his work. To inspire this confidence, he must be seen to be honest, truthful and fair, compliant with the concept of social responsibility, open and concerned with the interests of all stakeholders and demonstrative of taking corrective action where necessary. Integrity has to be underpinned by moral values and demonstration of scepticism, per-severance and ability to withstand pressure in the face of opposition.

As I look back over the last fifty years, I share a feeling of satisfaction that I have been part of a profession which has grown so fast and with so much success. It has done so because it has recognised early and been able to adapt better and faster than many other professions to the changing aspects of business and to exploit the opportunities which this changing aspect has offered. I have no doubt that in the coming decade, we will continue to remain the most dynamic seekers of new business opportunities if we continue to exhibit the qualities which have made this possible, namely, continually updated skills, integrity, social responsibility and strong regulation which protects the ‘brand equity’ of the Chartered Accountant.

Nirav Shah

Role of the Professional in the 21st Century

The Society which was born in the middle of the 20th century
has, in the beginning of the 21st, very appropriately dedicated the next issue
of its very popular and informative magazine to the ‘Role of the professional in
the 21st Century.’ One often speaks of a person being professional in his work.
This would normally denote particular efficiency in handling the matter
entrusted to him. However, one sometimes speaks of a person as being a ‘true’
professional and by this, one refers to him as a role model, not only in
experience, learning and dedication which he displays in handling professional
assignments, but also his character, rectitude, honesty, fairness and impeccable
integrity. At a time like the present when newspaper reports speak about a
professional having allegedly bribed a member of the Income-tax Appellate
Tribunal and the two having been detained, it is these latter qualities which
assume great importance.

Of course, there is another way of looking at the subject and
interpreting it as referring to the very wide role which a professional plays
today on account of the various opportunities before him — opportunities which
were non-existent, say, 20 years ago. The role of the Chartered Accountant has
become all pervasive and he is a vital link in the businessman’s operations. He
is no longer just an auditor but advises him on management and business
practices, computerisation and concluding large business deals. Indeed, auditing
is today looked upon as the less preferred alternative. This is perhaps because
it requires great courage on the part of the Chartered Accountant to certify
that what the client has done or proposes to do is not in keeping with the law
or good accounting practice. On the other hand, in other fields of his practice
he helps the client whilst as an auditor he looks after, inter alia, the
interest of the shareholder. So also with the advocate — appearance in Courts,
which was the mainstay of his professional practice is no longer so. Advice on
day-to-day matters relating to business and personal affairs of clients as well
as drawing up or settling complicated deeds to provide for the ever increasing
needs of business and arbitration proceedings have overtaken Court practice. In
this writer’s opinion there is, however, nothing so challenging and satisfying
as persuading a Bench to accept your client’s view, particularly if it is an
unorthodox view. However, it all depends on an individual’s approach. Everybody
does not relish a steak !

The ultimate test of the role of a professional is the
standing and the respect he commands and the value which people put on the way
he handles matters and not the number of matters he handles. In England,
previously they had amateurs and professionals playing the game of cricket and
the annual match at Lords used to be called ‘Gentlemen v. Players’, the
amateurs being the gentlemen. The captain of the English team would invariably
be a cricketer who qualified as an amateur (gentleman). (Len Hutton, later Sir
Leonard Hutton, was the first exception just about the time that the Society
started functioning.) This is no longer so. The annual match is discontinued.
One wonders whether this is because the gentleman has gone out of the game! In
my view a professional attains his ultimate role if he qualifies as a gentleman
professional and not just a successful or prominent professional.

In one way of looking at it, the qualities which a
professional must possess to discharge his role with distinction have remained
the same over time. After all, the Ten Commandments do not change from time to
time. They are enduring and of universal application. Nevertheless times are
changing — the 20 : 20 culture has replaced the flavour of a test match in
popular thinking. So also the general concept of a professional has undergone a
change. Advertising by a professional was, and is taboo in India. However, it is
rampant in the United States of America where one may find at a department store
handouts which one can pick up about the achievements of a lawyer and I presume
also of an accountant. At some international airports one finds posters or
hoardings with a photograph of the leading professional in a professional firm
who has achieved success and prominence in his field. Even in the UK today,
barristers are permitted to bring to the notice of the public their speciality
of practice but not a reference to cases won by them. The rule against
advertising in India is so strict that Rule 36 of the Code of Conduct framed by
the Bar Council of India specifically provides that the stationery of a lawyer
should not indicate that he is or has been a President or a member of the Bar
Council or any association or that he has been associated with any person or
organisation or any particular cause or matter or that he specialises in any
type of work or that he has been a judge or an advocate-general. Strictly
speaking therefore, the letterhead cannot state ‘formerly a judge of . . .’ The
Chartered Accountant is subject to equally stringent condition against
advertising. The classic view is that the client must seek out the professional
and not that the latter fishes for clients.

The other malaise is the publicity which professionals seek
by constantly voicing their views in the press in response to mobile requests.
The views are often based on newspaper reports or TV announcements without
having actually seen in black and white what they comment upon. This is, of
course, less reprehensible than the case of the politician who recommends
banning of a publication which he admits in a blase manner that he has not
read !

A prevalent practice today is for a professional to make
presentations to would be clients to show his particular expertise and sometimes
with a view to the client retaining him or his firm at the expense of the
professional currently working for him. This to me appears unsavoury. Of course,
the other point of view is that the client is a customer and it is proper that
he be made aware of the alternatives available just as a businessman advertises
the superior quality of his products.

It is urged in defence that a new entrant in the profession cannot get known unless he is permitted some degree of advertisement. Insofar as the presentations are concerned, the truth is that it is not the new and junior member who indulges in them, but the well-established and seasoned professional even though he does not have to fish for clients! Insofar as the junior and new entrant is concerned, there are several avenues open to him to get himself known. He can write articles in the professional as well as in the lay press, he can accept speaking engagements and he may even take up an assignment as a lecturer, all of which will give his image an exposure. This is particularly applicable to professionals practising in the ( fields of accountancy, law, management, etc. Indeed, the Society is a great place for a new entrant to have his voice heard. The Society as well as several other professional bodies encourage new and budding professionals by offering them speaking and writing engagements. In life there is always a right and a wrong way of doing things.

It is also to be borne in mind that a professional is not in the business of selling goods. Sethi J. observed in Saxena v. Sharma, 2000 7 SCC 264, “The professional obligations of a lawyer are to be distinguished from the business commitments followed by the trading community.” Vivian Bose J. in the case of Mr. G, a Senior Advocate of the Su-preme Court, AIR 1954 SC 557, pithily observed that the restraints which a lawyer is subjected to are a part of the price he pays for the privilege of belonging to a close and exclusive club, their integrity, dignity and honour shall be above the breath of scandal. There is a very important, firm and distinct line between a business and a profession, a line which unfortunately gets blurred as time passes. Some observations of the Supreme Court – would appear to make this line vanish. In Barendra Prasad Ray v. ITO, 129 ITR 295, the Supreme _ Court equated a business connection as also covering a professional connection. To the same effect is the observation of Rowlatt J. in Christopher Barkar & Sons v. IRe, (1919) 2 KB 222 wherein he observed that “All professions are businesses, but all businesses are not professions.” The observations have to be read in context and bearing in mind the issue involved. For example, in the Supreme Court case the issue was whether an Indian solicitor had a business connection with the barrister engaged by him. It would indeed be a sad day if no distinction is visible between a businessman and a professional. What distinguishes a profession from a business is that a profession has a code of conduct to which its members are subject and breach whereof would result in a disciplinary action. However, no written code of conduct could possibly cover all contingencies. Ultimately, the question to be asked is whether the conduct in question is that of a true gentleman. Often adherence to the unwritten code of conduct is more important because the written code is there for all to see. As very pithily observed in an old film ‘Seven Brides for Seven Brothers’, one has to honour an unwritten contract because the written contract can always be enforced.

Bose J. stated in AIR 1954 SC 557 that a professional “is expected at all times to comport himself in a manner befitting his status as ‘an officer and a gentleman.’ In the Army it is a military offence to do otherwise … though no notice would be taken of ungentlemanly conduct under the ordinary law of the land and none in the case of a civilian. So here, he (the advocate) is bound to conduct himself in a manner befitting the high and honourable profession to whose privileges he has been admitted; and if he departs from the high standards which that profession has set for itself and demands of him in professional matters, he is liable to disciplinary action.” It is for this reason that S. 21(3) of the Chartered Accountants Act, 1949 imposes a punishment not only for professional but also for ‘other’ misconduct.

In business, the driving force is money. That ought not to be the case in a profession. In the Preamble to the Standards of Professional Conduct and Etiquette formulated by the Bar Council of India and reported in the journal section of 68 Bom. L.R. 72 it is stated “An advocate shall, at all times, comport himself in a manner befitting his status as an officer of the Court, a privileged member of the communitp, and a gentleman, bearing in mind that what may be lawful and moral for a person who is not a member of the Bar, or for a member of the Bar in his non-professional capacity may still be improper for an advocate. Without prejudice to the generality of the foregoing obligation, an advocate shall fearlessly uphold the interests of his client, and in his conduct conform to the rules hereinafter mentioned both in letter and in spirit. The rules hereinafter mentioned contain canons of conduct and etiquette adopted as general guides, yet the specific mention thereof shall not be con-strued as a denial of the existence of others equally imperative though not specifically mentioned.”

What applies to a lawyer equally applies to any other professional. The introduction to the publication on code of conduct issued by the Institute of Chartered Accountants of India sets out that the overriding motto has to be pride of service in preference to personal gain.

An illustration which may bring out the difference that there should be in the approach of a professional and of a businessman is provided by what should be their respective reactions to the fact that a particular act or transaction which has scope to yield monetary gain may be visited with a penalty if held to be impermissible. The businessman may ask what is the extent of the penalty and if factoring in the quantum thereof would still make the transaction acceptable from the business point of view, then he may take the penalty in his stride. On the other hand, the professional would (should 7) say that a penalty would imply a breach of the law and an act which imposes a penalty must be avoided even though financially viable. My views may, of course, be regarded by the new and not so new entrants to the profession as archaic, but then I have been brought up in a culture where it was considered improper for Counsel to carry visiting cards and certainly not proper to distribute them to all and sundry at professional meetings. Today, this is regarded as essential ‘networking.’ Indeed, in some large and well-known firms abroad and perhaps in India also, the senior-most partner essentially confines his activities to client nursing and client development rather than client attendance. The worth of a partner is judged by the money he pulls in and not the quality of his work.

By saying that in the 21st century money is the measure of success, I do not mean that a profes-sional must not charge what he feels is his proper remuneration for the time spent by him and the effort put in by him over a period of years in attaining excellence. After all, he devotes his time and there is no mechanism by which the time ordained to him in this world can be extended. At the same time if a matter deserves his attention, he should not refuse the assignment because the client is not in a position to pay his fee or that he only accepts work from corporate clients.

Most unfortunately, it is not wholly unknown that the professional may tell a client or accept the sug-gestion of a client to raise his fees or perhaps even gross up the fees for the component thereof which is to be used to bribe on behalf of the client. The client assumes the role of an ‘innocent abroad’ as his accounts only show the payment of a profes-sional fee. I may be pardoned for saying that it is like a businessman who retains an assassin to get rid of a competitor and does not pull the trigger himself. Of course, this ‘refinement’ does not have to be practised where the client or the professional has access to the other type of money !

It is also unfortunate that sometimes in India one reads in magazines interviews with professionals where they flaunt the success achieved by them in handling certain cases, even revealing the names of the clients. Confidentiality of the client’s affairs is equally important in the 21st or even in the 25th century as in the earlier times.

Today, the aspect of a contingent fee has assumed importance. The rules governing the American Bar clearly permit the charge of a contingent fee i.e., a fee based on success. In India, this is not per-mitted both to the chartered accountant and the lawyer. One must, of course, recognise that the charge of a contingent fee does serve a purpose as it enables an indigent person to avail of professional services without himself being out of pocket. The main reason for discouraging the levy of a contingent fee is that it gives to the professional a personal interest in the litigation which may lead to his not being fair to the Court, Tribunal or Authority before whom he appears or to his adversary. This breeds the class of ambulance lawyers – who chase an ambulance to offer their services to the injured in an accident or to the heirs of the deceased! As in all things in life, one has to balance two competing viewpoints. Old-fashioned as I am, I would vote for ‘no contingent fee,’ which is also the view clearly expounded by the Supreme Court of India in AIR 1954 SC 557 referred to above.

Over the last 15 years, a sea change has taken place in the quantum of the professional fee charged. This is in line with the globalisation of the Indian economy because foreign professionals charge a fee infinitely more than do their Indian counterparts. It is not as if the calibre of the foreign professional is any superior to that of the Indian. One result of this is that the problem of ‘kick back’ has unfortunately increased. The kickback could be to the employee of a corporation or an employee in a professional firm or even to a partner in a professional firm. This is undoubtedly unethical. It is however, not just a recent development as even in the old days it was not unknown that budding I counsels shared their fee with the managing clerk in an attorney’s office, who had the disposing power over a brief. An interesting issue is posed by Clause (2) of Part I in the First Schedule to the Chartered Accountants Act, 1949 which enumer-ates as a misconduct the payment directly or indirectly of any share or commission in the fees or profits of a chartered accountant to any person other than a member of the Institute. Obviously, the permissive payment is to a member of the Institute who does professional work for the chartered accountant. I do not know whether as worded it would permit payment of a simple kick-back to a member of the Institute! I am sure, it would not as it would come within the all-embracing principle of conduct not becoming a professional (Chartered Accountant). I may only add that though the fees charged have multiplied, the professional must not overlook that there are several cases where free counsel and work is necessary.

In order to fulfil his role of being a good professional, the person must maintain his total independence. If the professional is on the Board of Directors of a company, he should not perform professional services for the company as one does not know when there may be a conflict of interest in his role as a professional and his role as a director of the company who has to look after the interest of the shareholders. In the USA, strict rules of the Sarbanes Oxley Legislation are meticulously applied. Insofar as the legal profession is concerned, Rule 8 of the Code of Conduct prescribed by the Bar Council of India provides that a lawyer who is a director shall not appear for the company of which he is a director. Unfortunately, these rules are sometimes flouted even by the highest. Sometimes they are skirted by putting forward a dummy professional as being in charge!

There is a misconception in the mind of the lay public that a professional ought not to accept an assignment on behalf of a person who in public perception is perceived to be guilty of the charge levied against him. This is totally wrong. The function of a professional is to put forward without mis-representation of facts the case of his client. The professional is supposed to be better suited by training to articulate his client’s view. He should not bend to the public diktat not to appear for a particular person. The person may have a perfectly good defence though at first blush it may seem improbable. The only exception where he may decline to appear is where there is some conscientious objection to his canvassing a particular point of view and not because he feels the client is guilty of the misdemeanour he is charged with, unless, of course, the client has confessed to the profes-sional his wrongdoing. In our system it is for the judge to adjudicate.

One must also distinguish between a professional person’s argument in a matter and his opinion.
The opinion has to be what he feels is the correct position on facts and in law. His arguments have to be what is most advantageous to his client without factual misrepresentation. He cannot be a judge and decline to urge a point which he feels may not be acceptable. On the other hand, his opinion has to be what it is stated to be, namely, his view of the correct position in law on the given facts. The ultimate tribute is when, say, an officer says that the assessee should obtain an opinion from XYZ as his opinion will really be what he believes to be true.

A very important professional development in the r 20th century insofar as India is concerned is the advent of foreign professional firms. As per present regulations, neither in the field of chartered accountancy nor of law can a foreign professional, who does not have the necessary Indian qualification or a foreign qualification recognised by the concerned apex body, practise in the field of chartered accountancy or law. The view is that to practise a profession does not merely mean ap-pearance in the Court or before an authority, but also performing any function which the said pro-fessional can perform. The writer feels that the right of a foreign professional to practise should be completely on a reciprocal basis. If the Indian professional can practise in that foreign country, then the professional of that country should be allowed to practise in India under the same terms and conditions. With the opening up of the economy, this is an issue which has assumed considerable importance. Here again one sometimes regrettably sees a surrogate practice being carried on. A fallout of increasing globalisation is that if a foreign company has an Indian associate, the audit of the associate company sooner or later gets transferred to the associate concern of the foreign company’s auditor. The homebred auditor is replaced not because he is less efficient or wanting in professional attainment, but because he does not have the necessary ‘connection.’ This is an unfortunate development per se. The defence, of course, is that this practice encourages uniformity of audit approach.

There is only one further aspect of the matter which requires to be considered. What are the special skills which the 21st century dictates for the professional? The first one which comes to mind is that one must train one’s memory to remember the relevant case law and facts. When one is arguing a matter before an authority and a question is put, it is in that split second that the professional must be able to provide the answer. This is particularly so when arguing before the Tribunal or a Court. Such response is possible if he has trained his memory to recall at pleasure the relevant case law on the subject. It is the 21st century computer mania which is a strong deterrent to the cultivation of a memory. Why should I strain myself when the information is available on the click of a button? A similar situation is reflected in the inability of the present generation to total mentally three sets of figures. The calculator is a great crutch. The other attribute which is required to be developed is the ability to put the argument in a succinct form. Gone are the days when judges had time at their disposal to hear lengthy arguments. One has to hit the target in the shortest possible time. Above all, one has to develop intuition and a sense of the moment. With the increasing workload one must know what to look for and what to ignore. As an auditor, a Chartered Accountant should learn by instinct to determine which aspects of a client’s accounts require particular scrutiny. Again a speedy reaction to a question is often called for. A client rings up with a question and expects a prompt response. One should be careful not to commit oneself if one is not sure of the position as later the response given by him may be held against the professional if it turns out to be inaccurate. Particular care has, therefore, to be taken in furnishing opinions, specially in writing, as years later what has been opined may be referred to and commented upon adversely. This is the reason why furnishing a written opinion is so much more difficult than arguing a matter. It is also more time-consuming than preparing for an appeal. Above all in the present era of tension and fast living, the professional must develop a sense of detachment and humour. He should not get carried away by ful-some praise showered on him. He must remember that it is only as long as he delivers that the client will hanker after him.

It is a wise man who said that if you want to find out how important you are, take a bucket and fill it with water, put your hand in it up to your elbow, pull it out and the ‘hole’ that remains is the measure of how you will be missed. You may splash all you please when you enter, but stop and you will find in a minute that it looks just the same as before!

I have, in this article, confined myself to the professions of accountancy and law as these are matters of prime interest to readers of this magazine. However, there is the profession of medicine which perhaps affects all of us intimately in our personal life. (Classically the three learned professions are the professions of divinity, law and medicine.) The doctor is the last resort when it is a matter of life and death. It appears to me to be unfortunate that today in the medical field there is over-specialisation. For every limb in the human body there is a specialist and sometimes he looks at the matter only from his point of view and not from a holistic point of view. Very soon we may have a specialist for the thumb or the little finger! Today pathological and mechanical tests have overtaken the innate diagnostic skill which the physician of old possessed. Of course, this is an offshoot of mal-practice litigation fears – fears to some extent fuelled by members of the legal profession. The great role of the doctor is that he administers to human beings and not to corporates as do high-flying members of the other two professions and this is also reflected in their respective professional fees !

In the ultimate analysis in determining whether a professional has fulfilled his role, one has to determine what he has contributed to the profession. His individual brilliance is undoubtedly to be complimented, but what is to be admired is how he passes on the knowledge which he acquired to another and trains him to enrich the profession. Unlike in the case of a businessman, a professional himself trains his article clerks, or juniors, as the case may be, to be independent and there is nothing so satisfying for the true professional as to see those whom he has trained shine in the profession and preferably even outshine him! The profession gives us much and the only way one can repay the debt is by putting others in the field. To be labelled a successful professional is not necessarily a compliment, but to be called a true professional is !

Nirav Shah

Real Estate Laws : Recent developments — Part II

Laws and Business

1. Introduction :

Last month, we examined some of the recent developments
pertaining to real estate in Mumbai and in India. This Article examines some
more developments which would have a far-reaching impact on property
transactions.

2. ULCRA repeal :

2.1 A few months ago, the State Government of Maharashtra
finally repealed the dreaded Urban Land Ceiling & Regulation Act (ULCRA).
Estimates say that this would release as much as 30,000 acres of land in Mumbai
alone. Several large land owning trusts are expected to benefit. Several lands
owned by mills such as NTC are expected to benefit.

2.2 The Government was under pressure to repeal ULCRA, since
the Centre had set a deadline of March 2008 to do so or else it could not access
over Rs.17,600 crore of funds under the Jawaharlal Nehru National Urban Renewal
Mission.

2.3 The Government is now toying with the idea of replacing
ULCRA with a vacant property tax. One can only hope such legislations do not see
the light of the day.

3. Increase in FSI in suburbs :

3.1 The State’s Finance Minister has in his budget speech
announced that the base FSI in the Mumbai suburban district would be increased
from 1 to 1.33 and brought on par with the FSI permissible in the island city.
The additional 0.33 FSI would have to be purchased as per the ready reckoner
rate for the area. Thus, instead of a developer constructing a building in the
suburbs by using 1.00 FSI and loading another FSI of 1.00 by buying Transfer of
Development Rights (TDR) from the market, as per the new proposal, the builder
would buy lesser TDR by 0.33%. Thus, builder can now purchase 1.33% from the
Government as FSI and only the balance 0.67% as TDR. This means more funds to
the Government. The maximum cap of FSI 2 for projects in the suburbs still
remains.

3.2 From a developer’s perspective, the cost advantage is
negligible, since the FSI rates are more or less comparable with TDR rates.
Further, the overall cap of 2.00 does not increase the overall supply of land,
it only substitutes one source (TDR) for another (FSI).

4. NOC for rented flats

4.1 The Supreme Court’s decision in the case of Mont Blanc
Co-operative Housing Society Ltd. has upheld the constitutional validity of the
State Government’s Notification dated 1st August 2001 that Non-Occupancy Charges
(NOC) levied by a society cannot exceed 10% of the service charges. Thus, a
housing society cannot charge more than 10% of the service charges in case of a
flat which has been rented out by its member. This was a vexed issue with
societies levying NOCs based on their own whims and fancies. In several areas
such as South Mumbai, the societies collected exorbitant amounts for flats
rented to consulates and corporates. For instance, in some case if the monthly
rent was Rs.10,000 and the maintenance charges were Rs.1,000, the Society
demanded 20% of that or Rs.2,000 as NOC. This was even higher than the
maintenance charges levied by the society.

4.2 The Supreme Court has granted temporary
relief to the Mont Blanc Society, allowing them to col-lect non-occupancy
charges at the rate of 10% of gross earnings of members till the final disposal
of the petition. All other societies in Maharashtra will have to adhere to the
Notification, and charge not more than 10% of the service charges, excluding BMC
taxes. The Notification had been issued u/s. 79A of the Maharashtra Co-operative
Societies Act, 1960.

5. Stamp Duty proposals :

5.1 The Maharashtra Government has once again decided to milk
its favourite cash cow, the Stamp Act. As per the revised estimates for 2007-08,
the Government is expected to net Rs.8,000 cr. from stamp duties alone and this
figure is estimated to cross Rs.9,600 crores for the year 2008-09.

5.2 Currently, development agreements and power of attorney
for development attract Stamp Duty @1% of the fair market value of the property
involved. Now Stamp Duty on these documents would be levied on rates as
applicable on a conveyance, i.e., @ 5%. Thus, the Government is equating
development agreements with conveyance deeds. It is submitted that this is not a
welcome amendment, since a DA cannot be equated with a conveyance.

5.3 Earlier, any power of attorney authorising the holder to
sell immovable property, if not given for a consideration, was chargeable with
Stamp Duty only at Rs.100. Now any power of attorney authorising the holder to
sell immovable property, whether or not given for a consideration, is
chargeable with Stamp Duty @ 5% of the market value of the property. A rebate of
this duty paid would be given while calculating the Stamp Duty on a conveyance
executed pursuant to the power of attorney between the donor and the holder of
the power.

An exception has been made for a power of attorney given to
close relatives, such as parents, spouse, children, grand children, siblings,
etc., authorising them to sell immovable property. In such cases, the duty would
be restricted to Rs.500. Hence, consider a situation where the owner of a
property is a non-resident in London. He has no family members in Mumbai and
wants to sell his property and hence, gives a power of attorney to his friend in
Mumbai. Obviously, this would be without consideration. This would now attract
duty @ 5% of the market value of the property. Is this fair ?

5.4 Presently, if after purchasing a flat from a developer it
is resold within 3 years of the date of agreement then while paying the duty on
the second agreement, credit is given of the duty paid on the first agreement.
Now this concessional period has been reduced to one year. Hence, now, if after
purchasing a flat from a developer it is resold within a period of one year of
the date of agreement, only then while paying the duty on the second agreement,
credit would be given of the Stamp Duty paid on the first agreement.

5.5 As a consequential amendment to the deemed conveyance amendment (see para 5.2 above), it is proposed to introduce an amnesty scheme in order to provide for concessional Stamp Duty on the conveyance of the underlying land, since if the building has been purchased some time back, then it would be unjust to collect Stamp Duty at present rates. Details of this amnesty scheme would be notified soon.

5.6 Like in other taxes, e-payment would soon be possible for Stamp Duty also. An e-Payment Gateway would be made available to the taxpayers. This will enable them to pay taxes conveniently at any time and from anywhere through Internet. The amendments which are required to be made to the rules under different tax laws, will be carried out in this year.

6. Sale of stilt parkings:

6.1 The Bombay High Court recently in the case of Panchali Cooperative Housing Society Ltd. at Dahisar held that the builder, NL Builders Pvt. Ltd., had no right to sell stilt parking areas in the society to outsiders. The Court dismissed the builders’ petition claiming that his right in the property developed by him is absolute. The builder had claimed that he had a right to sell that portion of the property that remained unsold, i.e., some of the stilt parking slots.

The Court held that as per the Maharashtra Ownership Flats Act, 1963, once the builder conveys the property to the society, and it is registered, the property belongs to the society.

6.2 This judgment settles an important principle regarding the rights of a society and a builder.

7. MOFA: Sale on carpet area basis:

7.1 The latest amendment in the real estate laws is a change to the Maharashtra Ownership Flats Act, 1963 (MOFA). Builders would now no longer be able to sell flats to buyers on the basis of the super built-up area. The amendment provides that builders must sell flats on the basis of the carpet area.

7.2 Builders normally sell flats on the basis of super built-up area or built-up area. The differences between the three types of areas are as follows:

Carpet Area : It is the internal area of a flat. It is the wall-to-wall area of the flat.

Built-up Area: It covers walls and balcony also.

Super Built-up Area: It includes the lobby, passage, elevators, fire fighting area along with the total utility. In other words, it covers common areas too. Sometimes, even the garden is included.

In some cases, the built-up area is 20% of the carpet area and the super built-up area is as high as 40% of the carpet area. However, these figures are subjective and vary from builder to builder and in some cases even building to building. Thus, there is a great deal of confusion in the flat purchasers’ minds who are often unable to understand the exact difference between carpet area, built-up area and super built-up area of a flat. The amendment would remove all such ambiguities. Any violation of this act can mean a 3-year imprisonment for the builder/promoter, proposed as per S. 13(A) of the Act.

7.3 While the amendment provides that developers can “sell the flat on the basis of the carpet area only”, they may separately charge for the common areas and facilities in proportion to the carpet area of the flat. Hence, they can continue to charge for common areas and facilities like staircases, lobby and lift as per the super built-up area concept. The only caveat is that the buyer must be made aware of the cost of the carpet area, which is the net usable wall-to-wall area of the flat.

8. Reverse mortgage scheme:

8.1 A few months ago, National Housing Bank (NHB), the housing finance regulator, announced the final operational guidelines on reverse mortgages. A reverse mortgage product seeks to monetise the house as an asset and specifically the owner’s equity in the house. The scheme involves senior citizen borrowers mortgaging their property to a lender, who makes periodic payments to borrowers during their lifetime.

8.2 A senior citizen who is living in his own house may obtain a reverse mortgage loan (RML) and have a recurring income by mortgaging his house to banks or other financial institutions. He can also be a joint borrower with his spouse, provided at least one of the borrowers is above 60 years. Thus, the minimum age limit for availing this scheme is 60 years.

The draft guidelines provided that in case of married couples being eligible as joint borrowers, both of them must be above the age of 60 years, but that has now been relaxed to include those couples where at least one of the borrowers is 60.

8.3 In the event of the death of the husband who may be the owner of the property, the wife – who may be a co borrower but not co-owner – will receive income. The lender will not evict the wife, but will modify the cash flow.

8.4 The recent Finance Act, 2008 has clarified that any transfer of a capital asset under a scheme of reverse mortgage would not be chargeable as capital gains. Further, the loan amount received by the borrower will not be included in the total income. The changes made in respect of ‘reverse mortgages’ have clarified doubts and has made the scheme workable.

Nirav Shah

Shops & Establishments Act

Laws and Business

1. Introduction :

1.1 The Bombay Shops and Establishments Act, 1948 (‘the
Act’) regulates the conditions or work and employment in shops, commercial
establishments, residential hotels, restaurants, theatres, other places of
public amusement or entertainment. It applies to the whole of Maharashtra.

1.2 The Act operates in municipal areas specified in Schedule
I to the Act. However, the State Government has power u/s.4 to exempt all or any
of the provisions of the Act to any establishment, employees or other persons.

2. Definitions :

2.1 Establishment — A shop, commercial
establishment, residential hotel, restaurant, theatre, other place of public
amusement or entertainment to which the Act applies and any other establishment
which is notified by the State Government.

2.2 Commercial establishment — It means an
establishment which carries on any business, trade or profession or any work in
connection with or incidental or ancillary thereto. The following establishments
are included within the definition of the term commercial establishment :

Legal practitioner —
However, the same has been held to be invalid and has been struck down by the
decision in the case of N. K. Fuladi v. State of Maharashtra, 1985 1 LLJ 512 (Bom.)

Medical practitioner

Architect

Engineer

Accountant — However, the
same has been held to be invalid and has been struck down by the decision in
the case of A. F. Ferguson & Co. v. State of Maharashtra (Bom.)

Tax consultant

Any other technical or
professional consultant

2.3 Employer — means a person having owning or having
ultimate control over the affairs of an establishment.

3. Registration :

3.1 Every establishment to which the Act applies must apply
for registration with the inspectors designated under the Act within the
specified time. The application must be made in the prescribed form along with
the prescribed fees.

3.2 The inspector would on being satisfied about the
application, register the establishment and issue a certificate of registration
to the employer. This certificate needs to be renewed every year.

3.3 Any change in the particulars submitted while making the
application must be communicated to the inspector by the establishment. Further,
within 10 days of closure of the establishment, the employer must communicate
such fact to the inspector and get his certificate cancelled.

4. Regulation of establishments :

4.1 The Act lays down the opening and closing hours of shops
and commercial establishments. For instance, no commercial establishment can be
opened earlier than 8.30 a.m. and close later than 9.30 p.m. It also empowers
the State Government to modify the same for different classes of shops and
commercial establishments. Offices which work “It also specifies that no
employee can be made to work for more than 9 hours per day and 48 hours in any
week.

4.2 Every shop and commercial establishment must remain
closed for one day in a week, e.g., a Sunday. The employee cannot be called for
work on this day and must be paid his salaries as if he has attended office on
that day.

4.3 The Act also prescribes similar rules for residential
hotels, restaurants, theatres or other places of public amusement or
entertainment.

4.4 Anybody who is between 15 and 17 years of age is
considered to be a young person. No young person can be required or allowed to
work, whether as an employee or otherwise, in any establishment

(a) after 7.00 p.m.

(b) for more than 6 hours in any day; and

(c) if the work involves danger to life, health or morals.

Women cannot be allowed to work in any establishment after
9.30 p.m.

4.5 Every employee, who has worked for at least 3 months in a
year, shall be entitled to leave of 5 days for every 60 days of service during
the year. However, if he has worked for at least 240 days in a year, then he is
entitled to 21 days leave. Further, he would be entitled to additional holidays
on certain days, such as 26th January, 15th August, etc. An employee is
prohibited from working when he is given a holiday or is on leave as per the
provisions of the Act.

4.6 If an employer wants to terminate the services of any
employee who has been working for a continuous period of one year or more, then
he needs to give him a notice period of 30 days. If this is not done, then the
termination is bad in law and the employee can claim reinstatement with full
wages. However, this provision would not apply in case of a termination due to
misconduct.

4.7 It should be remembered that the State can, on an
application, exempt the operation of the above provisions to any establishment
or employee. For instance various 5-star hotels have got exemptions from the
provisions of S. 33 which mandate that women cannot work after 9 p.m. However,
various conditions have been imposed while granting such an exemption.
Similarly, BPOs have got exemptions from some of the provisions pertaining to
working hours, etc.

5. Application of other laws :

5.1 The State Government may prescribe that the Payment of
Wages Act, 1936 shall apply to any class of establishments or employees to which
this Act applies.

5.2 The provisions of the Industrial Employment (Standing
Orders) Act, 1946 apply to any establishment to which this Act applies as long
as it employs more than 50 employees.

5.3 The State Government may prescribe that the Maternity Benefit Act, 1961 would apply to any establishment to which this Act applies.

6. Health & Safety :

6.1 Every establishment shall be kept clean and have proper ventilation. It must be sufficiently lit during all working hours. The Act prescribes standards for the same.

6.2 Every establishment must take precautions against fire. Further, certain types of establishments must also maintain a first-aid kit.

7. Registers & inspection :

7.1 The Act requires establishments to maintain such registers and records and display such notices as may be prescribed. The rules framed under the Act require every establishment’s name board to be in Marathi in addition to any other language. However, the lettering of the Marathi script should be of the same size as that of the other language.

7.2 The inspectors appointed under this act have power of entering and inspecting any establishment, examine the prescribed registers and records, take evidence of any persons he considers necessary.

7.3 The Act prescribes various penalties for contravention of the provisions of the Act. For instance, S. 52 lays down the penalties for contravening a majority of the provisions of the Act. It specifies a penalty of Rs.1,000 to 5,000 for each offence. There is also an enhanced penalty for repeat offenders who have already been convicted under the Act.

Role of a CA :

A CA can make his clients about the provisions of this Act and enlighten them about the requirements of compliance with the Act. This would be a value-added service which he can provide to his clients. He can also undertake a compliance audit for his clients. By broadening his peripheral knowledge, a CA can add value to his services.

Nirav Shah

Renting of immovable property — A dilemma for property owners

Nirav Shah

Sale of flats not being a ‘service’, builders not liable for registration and payment of Service Tax

New Page 2

Sale of flats not being a ‘service’, builders not liable for
registration and payment of Service Tax :

Magus Construction Pvt. Ltd. v. Union of India, (2008
TIOL 321 HC GUW ST)

1. The petitioner, a builder, promoter and developer engaged
in the business of development and sale of immovable property received a notice
from the Superintendent to register as service provider of commercial and
residential construction services. Challenging the authority to issue such
notice, the present writ petition was filed.

2. The petitioner constructs buildings and sells
premises/flats in such buildings. The petitioner pleaded that the transaction
between the petitioner and a flat purchaser is a transaction for sale of
premises and cannot be treated as contract for rendering service. The
consideration for the sale of premises is often paid in instalments though the
terms correlate more or less with the stage of development of construction. The
agreement for sale of such flats is stamped as ‘sale of flats’ for the entire
consideration. The agreement for sale is registered by the petitioner. The
agreement contains several details including price, area of the unit, price for
common areas, other facilities concerning the flat, etc.

3. The petitioner engages various reputed contractors for
various construction-related services, yet the construction activity is carried
out for their own purposes and not for anyone else. In some cases where land is
owned by a different person and not the petitioner, an agreement is entered into
with the land owner and this in common parlance is known as development
agreement. After acquiring all the rights of development and raising
construction thereon, constructional or developmental activity is carried out by
the petitioner for its own benefit and not for any other person. The flats are
sold in the same manner as in the case when the land is owned by the petitioner.

4. According to the Department’s affidavit, the activity
undertaken by the builders is for and on behalf of prospective buyers for
consideration of cash or deferred payment and is covered under ‘works contract’
and not ‘sale’. The Department argued that the builder has to enter into
agreement for sale before accepting money as advance/deposit when building/flat
is found only in specifications of the agreements. The saleable products not
being existent at the time of making agreement, construction is the essential
obligation of the petitioner and therefore the petitioner is to be treated as
service provider of construction of complex to the parties in compliance with
the agreements against the advance received according to the statutory
provisions provided in S. 65(105)(zzzh) of the Finance Act, 1994, which are wide
enough to include estate builders such as the petitioner. Since the agreement is
executed prior to the completion of work of construction, it is nothing else but
‘works contract’ and as such, the petitioner is liable to pay Service Tax and
the advance received makes the petitioner work for and on behalf of prospective
buyer.

5. The Court noted that the moot question in the petition
related to whether the petitioner worked as a service provider for prospective
buyers with whom the agreements were entered into OR the petitioner constructs
flats for the purpose of sale to those with whom the agreements are entered into
and proceeded to scrutinise the relevant clauses of the said agreements which
mainly contained details of instalments, the obligation of prospective buyer to
pay stamp duty and registration fee as per applicable laws, etc., the probable
time of handing over possession and the condition that possession would be
provided only after full payment of the sale price and that after payment of all
dues, a sale deed would be registered in favour of the prospective buyer as per
prevailing Stamp Act, Registration Act, Property Transfer Act, etc.

6. The Court observed that the combined reading of various
clauses of the agreement for sale made it clear that the transaction relates to
purchase and sale of premises and not for carrying out any constructional
activity on behalf of the latter. The flat purchasers are entitled for specific
performance of the contract and non-performance may lead to refund of advance
with interest by the petitioner. They also have an obligation to register the
agreement. Further, the registering authority also treats these documents as
agreement for sale/purchase of premises and not relating to construction
activity and as such, stamp duty is levied on the sale consideration.

7. The ‘selective approach’ for taxing services under Service
Tax provisions and the relevant enabling provisions of the Indian Constitution
were discussed at length by the Court. Similarly, the provisions of the Finance
Act, 1994 relating to charge of Service Tax, payment of Service Tax,
registration, relevant provisions of ‘taxable service’ and in particular S.
65(30a), S. 65(25b), S. 65(91a), S. 65(105)(zzq) and 65(105(zzzh) were
discussed. The Court further noted that the term ‘service’ is not defined by the
Finance Act, 1994 by way of any explanation or otherwise or by the rules framed
thereunder. The Court therefore examined the definition of service under the
Income-tax Act, 1961, under the MRPT Act, 1969 as well as under the Consumer
Protection Act and under the FEMA and concluded that one can safely define
‘service’ as an act of helpful activity, an act of doing something useful,
rendering assistance or help, service does not involve supply of goods;
‘service’ rather connotes transformation of goods/user of goods as a result of
voluntary intervention of ‘service provider’ and is an intangible commodity in
the form of human effort. To have service, there must be a ‘service provider’
rendering services to some other person(s), who shall be recipient of such
‘service’.

8. Under the Finance Act, 1994,Service Tax is levied on taxable service only and not on service provider. According to the Court, the relevant legal provisions of Service Tax did not support the view that the petitioner provided any service to anyone and that the activity carried out by a person for his own benefit cannot be termed as service rendered. The Court took note of Circular No. 80/10/2004, dated September 17, 2004, which clarified that estate builders constructing buildings/premises for themselves were not covered within the ambit of construction service. Further, the decision in the case of K. Raheja Development Corporation v. State of Karnataka, (2005) 5 SCC 162 was discussed and was distinguished by noting that this decision was rendered on the facts of its own case. The Court emphatically stated that until the time the sale deed is executed, the title and interest, including the ownership and possession in the construction made remained with the petitioner company. The fact of payment of advance and instalments does not lead to the inference that petitioner company is making construction for and on behalf of the probable allottees. The Court also stated that the decision of the Apex Court in K. Raheja’s case (supra) considered the issue relating to Sales Tax and not relating to Service Tax. According to the Court, as distinguished from the facts of K. Raheja (supra) in the present case, there was no material to show that the petitioner company constructed the premises on behalf of the prospective allottees and also stated that similar view was taken by the Allahabad High Court in the case of Assotech Realty Pvt. Ltd. v. State of Uttar Pradesh, (2007) 8 VST 738.

9. Further, importantly reliance was made on Circular No. 332/35/2006-TRU, dated August 01, 2006 which clarified that the builder/promoter/developer undertaking construction activity on one’s own account did not have relationship of service provider and service recipient with anyone and therefore the question of providing taxable service did not arise. Citing extracts from CIT v. Aspinwall & Co. Ltd., (1993) 204 ITR 225, Keshavji Raoji & Co. v. CIT, (1990) 183 ITR 1 and a catena of other decisions, the binding nature of the circular was affirmed by the Court and it finally contended that the aforementioned Circular dated August 01, 2006was binding on the Department which in more than abundant terms made it clear that a builder /promoter / developer undertaking construction activity for its ownself did not provide any taxable service. The material placed by the petitioner clearly showed that the activity undertaken by them is their own work and they only sold the completed construction work to the buyers. Any advance/deposit received was against consideration of sale of the flat/premises and not for obtaining service from the petitioner.

Note: The above decision is in complete contrast to the Authority for Advance Ruling’s (AAR) decision in case of Hare Krishna Developers 2008 (10) STR 341 (AAR) reported in June 2008 issue under this feature on almost identical facts and clauses of the agreements under both the cases. The ruling of the AAR being binding only on the applicant, the decision of the High Court assumes significant importance. Major contrasting features of the two decisions pronounced by the two separate judicial authorities are provided below:

1. In both the cases, the agreement with the prospective buyer relates to SALE OF UNITS. However, in Hare Krishna’s case (supra), it is contended by the authority that the point of time at which the ownership gets transferred will not be determinative of applicant’s liability to pay Service Tax. The words ‘in relation to’ used in the context of ‘construction of the complex’ are of widest import and are capable of encompassing builders/developers. AAR noted that “package of services is necessarily involved in the activity viewed as a whole”. Not merely construction part of the activity that matters, the co-related and incidental services are all embraced within the scope of the definition and the builder / developer does everything to honour its commitment to the customer (booker) from whom it receives valuable consideration in instalments. As against this, in case of Magus narrated above, distinguishing features are as follows:

Sale of units/premises to be subject matter of the transaction between the builder and prospective buyer.

Advance and instalment received are looked upon as a convenient method of payment. The judgment further brought out the contention that until the execution of sale deed, the title, interest and ownership and possession of construction remains with the builder and therefore, no construction is done on behalf of probable allottees.

A good amount of stress is laid on registration by registering authorities as agreement of sale/purchase of flats and the relevant stamp duty levied thereon. (In Hare Krishna’s case, this aspect is not touched upon).

An overall inference of ‘sale’ aspect is drawn rather than laying stress on details of facilities mentioned in various clauses while interpreting ‘sale of flat’ from combined reading of the clauses of the agreement and concluding that no construction activity is carried out for buyers.

A lot of effort is put in to distinguish ‘service’ from ‘service provider’ vis-a-vis statutory provisions to contend that there being no ‘service’ in the transaction of sale of flats, the builder is not a service provider for his own business activity where there is no recipient of service present.

2. In case of Hare Krishna, the Department’s reliance on Raheja’s case [2006 (3) STR 337 (SC)], as alternative contention was not discussed or considered while delivering for judgment, as chief reliance was placed on the fact that transaction was regarded as that of construction services in terms of clause (zzzh) and in terms of Classification Rules, ‘construction service’ was the correct classification entry even if the service could be classified as works contract service as per K.Raheja’s case (supra) and therefore, alternative contention was not gone into. As against this, Gauhati High Court distinguished K. Raheja’s decision on two counts: Firstly, the judgment was given on its own facts and secondly, that it related to SalesTaxand not ServiceTaxand therefore was not considered relevant.

3. In Hare Krishna’s case, the Board’s Circular dated August 23, 2007only was considered. Further, the said Circular was interpreted to be distinguishing the applicant’s case from the person/builder who sells flat after completing the entire construction on his own and then selling the same. Whereas in Magus’s case, the Circular No. 80/110/2004 of September 17,2004as well as the Circular of August 01, 2006 were discussed and the latter Circular was heavily analysed and relied upon. These Circulars were not referred to in the former’s case.

Nirav Shah

Compounding/settlement mechanism

Nirav Shah

The prescribed procedure

New Page 2

3. The prescribed procedure :

The declaration in respect of Service Tax/interest/penalty and the amount
payable is required to be made in a prescribed form viz. Form 1, to be
furnished in duplicate and to be signed by the declarant or his authorised
representative and to be submitted to the designated officer (an officer not
below the rank of Assistant Commissioner) notified by the jurisdictional
Commissioner for the purpose of the scheme, between July 01, 2008 and
September 30, 2008.

The designated officer is required to verify the submitted declaration and
upon such verification, is required to issue an order in specified format
within 15 days of the date of receipt of the declaration. The order would
indicate the amount to be paid by the declarant for resolution of dispute
under the scheme.

The declarant is required to pay the sum determined by the designated
authority vide the order described above within 30 days and intimate such
payment along with the proof of payment. The declarant is also required to
produce evidence of withdrawal of petition pending before any High Court or
the Supreme Court, if any.

The payment under this scheme is to be made in cash only.

à
On receipt of the proof of payment determined in accordance with the order and
the proof of withdrawal of petition, if any, to any Court, the designated
authority would be required to issue a certificate in a prescribed form
viz. Form 2 certifying full and final settlement of the amount in dispute.

levitra

Nirav Shah

The Scheme

New Page 2

2. The Scheme :

The scheme comes into force on July 01, 2008 and will close on September 30,
2008, meaning thereby that immunity under the scheme would be available only
to those cases in respect of which declaration is made under the scheme
between the stated period.

The scheme is open to persons in dispute for Service Tax, interest or penalty
leviable under the Finance Act, 1994, but not paid prior to March 01, 2008 and
where a show-cause notice has been issued on or before March 01, 2008 or an
order has been issued.

The scheme is open to cases where service tax in dispute does not exceed
Rs.25,000. The scheme is not open to cases where service tax is not paid after
collecting the same from the recipient of service for which a notice u/s.73A
of the Finance Act, 1994 has been issued.

[It may be noted that no limit is prescribed for the amount
of interest or penalty in dispute].

The order passed under the scheme would be final and non-appealable. Any
pending appeal shall stand withdrawn by virtue of the said order. In case of a
writ petition pending before any High Court or the Supreme Court, the person
opting for the scheme is required to withdraw such petition.

The amount paid under the scheme is non-refundable under any circumstances.

The Central Government is empowered to remove difficulties for implementation
of the scheme.

levitra

Nirav Shah

Background

New Page 2

1. Background :

The much publicised and hyped Dispute Resolution Scheme 2008
was notified vide Chapter VI of the Finance Act, 1994. The Government has now
issued Notification No. 28/2008-ST, dated June 04, 2008 whereby the rules called
the Dispute Resolution Scheme Rules 2008 have been prescribed. Further,
guidelines in respect of the scheme have been provided vide Circular No.
102/5/2008-ST, dated June 04, 2008. The operation of the scheme, the procedure
to be followed and settlement mechanism is provided below :

levitra

Nirav Shah

Interview – Justice Ajit P. Shah

InterviewJustice Ajit P. Shah recently
retired as Chief Justice of the Delhi High Court after a term of 2 years. Prior
to that, he was Chief Justice of the Madras High Court for over 2 years and a
judge of the Bombay High Court for almost 13 years. He is regarded as one of the
finest judges. During his long tenure as a judge, he passed various landmark
judgments pertaining to right to information, rights of disabled, environment
and homosexuals. Hailing from a family of lawyers and judges, he is known for
his forthright and progressive views. In interaction with the BCA Journal, he
dwelt upon a variety of issues pertaining to law and the legal system.

Challenges before Judiciary :

BCAJ
What are the major problems and challenges faced by the judiciary (and judges
in particular) today ?

APS Our legal system and judicial apparatus suffer from a
number of ailments. Our courts at all levels are burdened with dockets that are
bursting at seams. Around three crore cases are pending in the lower courts and
the High Courts. Our procedures tend to convert every litigation into a process
which puts more stress on the form rather than on the content. Our tools and
techniques of court management, docket management and case management continue
to be archaic and still depend on the advice of ‘generalists’ rather than
managerial expertise. Alternative Dispute Resolution system we all love to talk
about also seems to be reducing into more tokenism rather than becoming a potent
tool to make a real impact. Criminal justice administration perhaps remains the
most neglected area where the truth is (more often than not) the casualty and
where reform or rehabilitation seems to be the last priority. The courts are
able to dispose of on an average only 19% of the pending criminal cases. Around
two lacs undertrials are actually in prisons. The state of the prisons and
lock-ups is a cause of grave concern. Overcrowding in prisons is a rule rather
than an exception. These are some ground realities that cannot be brushed under
the carpet. They individually and collectively point to our failure at some
levels in discharging our obligation to provide good governance through an
effective legal system.

BCAJ The Government as well as the judiciary has been
talking about backlog of cases. What are the causes of delay ? Is the main cause
inadequate number of judges ? How far are the advocates and lawyers responsible
for delaying the proceedings ?

APS Yes, we have been talking about backlog of cases for
a long time but unable to find a solution to this gigantic problem. There are
many causes for delay and one of the main causes is certainly the lack of
adequate number of judges. The Law Commission in its 120th Report recommended
that the strength of judges per million population may be increased from 10.5 to
50 judges. The present judge strength in India is 14 per million population
(approx.). The Vision Paper published by the Law Ministry talks of appointment
of 15000 ad hoc judges in the subordinate courts and running courts in three
shifts. More than eight months have passed but no progress has been made. The
idea of appointment of 15000 ad hoc judges at one go and running the courts in
shift system is basically flawed and is impracticable and unworkable. The
establishment of Gram Nyayalayas has not made much progress due to lack of
support from the State Governments. The need of the hour is to plan gradual
increase in the strength of judges. The infrastructure provided to the judges in
most of the States is inadequate and in some places it is virtually
non-existent. There is a need for firm commitment of the Central and the State
Governments for making available the necessary infrastructure and financial
resources to the judiciary.

No amount of reforms would be meaningful unless the Bar joins
as partners in the stakes involved. Unfortunately, willingness of the lawyers to
embrace reforms seems to be amiss. Kathryn Hender from the Law School University
of Wisconsin posed a very serious question in an article begging for an answer
in the title itself as to whether the legal community represents ‘gentlemen of
change or unchanging gentlemen’. Professor Madhava Menon writes about the fear
psychosis in the judiciary or political class when it comes to confronting the
Bar which is vastly responsible for the major ill of the system, namely, delay,
cost and corruption. Adjournment culture, strikes and boycotts by the lawyers
have virtually paralysed the judicial system. There should be a concerted effort
from the Bench and the Bar to eliminate this menace. Administration of justice
is a joint venture in which lawyers and judges are equal participants. This is
all the more reason why both must take the stick for the ills that plagued the
judicial system and why they must share the responsibility for reforms.

BCAJ In your opinion, what steps need to be taken to
address the delay in disposal of matters ?

APS The first and foremost priority is to increase the
number of courts. This could be achieved in a phased manner in the next four or
five years. Secondly, as suggested by the Jagannadha Rao Committee it would be
necessary to assess the impact of every new legislation in terms of the burden
it would put on the judicial system. The burgeoning load of cheque bouncing
cases is a glaring example of lack of planning. In Delhi out of the pendency of
9 lac criminal cases, more than 6 lac cases are u/s.138 of Negotiable
Instruments Act. In 2009, Delhi Courts disposed of around 1.6 lac such cases, of
which only 400 were disposed of through a trial and the rest were disposed of
either by settlement or withdrawal. Perhaps these cases can be tried in shift
system even by appointing ad hoc judges. The Government should also consider
taking out petty criminal cases from the regular judicial system, so that judges
can concentrate on more serious cases pertaining to the law and order.

Alternative Dispute Resolution (ADR) has been the buzzword for the past two decades. Mediation is now increasingly used as an adjunct to the litigation system in the US and in several other western countries. This is not a marginalised phenomenon, but has been introduced as a case management imperative. Unfortunately, after the build-up of a positive public opinion and securing general cooperation of the Bar (which was originally very resistant) for the past few years, there is a downslide trend which is very disturbing. Mediation centres were set up through missionary zeal of judges who also developed a cadre of trained mediators to run them. Latest statistics signal waning enthusiasm on the part of the judges reflected in steadily declining references and the rate of settlements (For example, the Bombay High Court and the Madras High Court). The Delhi High Court is one of the few courts where mediation policies are being successfully implemented. Especially District Court Mediation Centres are doing extremely well with reported success rate of 15 to 20% of the total filing.

One of the important tools of ADR in use for many years now is the forum of ‘Lok Adalat’. The problem with this forum is that the proceedings are dominated by judges both as organisers and presiders. Correspondingly, the role of lawyers is notably diminished, compared to regular courts. There is a need to revamp the Lok Adalat organisation making it more participative including the robust support from the Bar.

Reforms in many fields remain incomplete unless they also utilise modern technology. It is not right to run the court system in the 21st century using a system which is developed in the 19th century. The courts must take advantage of the new technologies and adapt new ways of working. However, full potential of computers has not been fully and optimally tapped. There is no thought about reaping the real benefits of computerisation by redefining our needs and re-engineering our processes. The entire case information system ought to aim for providing a comprehensive management to exploit the available human resources fully.

The Delhi High Court has achieved significant success in full utilisation of information technology and at least two e-courts (paperless courts) are functioning in the Delhi High Court and one e-trial court has become functional for the first time in India. The Delhi Government fully backed the High Court in computerisation process. The technology involved, if put to optimum use, will virtually revolutionise the case management. It all boils down to change of the mindset and adaption to rapidly advancing technology.

The Delhi High Court, in one of its initiatives undertook the task of examining the issue of arrears. The Committee of Hon’ble Judges analysing the data scientifically, came out with certain concrete suggestions with regard to the distribution of business amongst various benches, suggested clear targets and change in the rule of procedure. The changes introduced in wake of the report have given encouraging results within a year.

Judicial appointments :

BCAJ Do you feel that the system and procedures for appointments of higher judiciary is sound ?

APS India is perhaps the only country in the world where the judiciary makes the appointments to itself. In the Second Judges’ case, a larger Bench of the Supreme Court reversed the view in SP Gupta’s case and declared that the word ‘consultation’ appearing in Article 142 of the Constitution should be read to mean ‘concurrence’, thereby vesting the CJI with the final say in the mater of appointments. The power so vested in the judiciary would be exercised through the collegiums consisting of the CJI and two most senior colleagues. In the Third Judges’ case, the Court slightly altered the process by directing that the CJI shall make a recommendation to appoint a Judge of the Supreme Court in consultation with four senior-most puisne judges of the Supreme Court and insofar as the appointments to the High Courts are concerned, recommendation must be in consultation with the two senior-most judges of the Supreme Court.

There is a considerable controversy about whether the Court has not amended the language of the Article by purporting to interpret it. This new dispensation of appointment and transfer of judges laid down by the Supreme Court has not been well received in India. The Bar and other sections of the society have been critical of this. For example, Mr. T. R. Andhyarujina has said : “A collegium which decides the matter in secrecy lacks transparency and is likely to be considered a cabal. Prejudice and favour of one or other member of the collegium for an incumbent cannot be ruled out.” Justice Krishna Iyer has described the pro-tem collegiums — “an egregious fabrication, a functioning anarchy”.

Vesting the power of appointment only in the executive or the self-selection by the judges are both fraught with difficulties. Hence, the trend now in modern constitutions, is to entrust the power of recommendation for judicial appointments to an independent council or commission. Such a council or commission is composed of representatives of institutions closely connected with administration of justice. The civic society also gets adequate representation. Such councils are now functioning in England, Wales and South Africa. The 1998 European Charter on the Statute of Judges also recommends selection by independent commission where at least 50% of the members should be sitting judges. In the USA, a candidate nominated by the President for appointment to the Supreme Court has to face public hearings conducted by the Senate.

BCAJ Unfortunately, of late, corruption seems to have crept into the judicial process as well. What are the probable causes of this ? Are the judges underpaid so that they are lured ? What needs to be done to arrest this trend ?

APS There is no point in saying that there is no corruption in the judiciary. Corruption has definitely crept in the lower judiciary and in some States it has reached disturbing levels. The higher judiciary also cannot be said to be completely free from corruption, though, in my opinion, it is marginal. Former CJI S. P. Bharucha has publicly stated that nearly 10% of the judges of the superior judiciary are corrupt. At present, two High Court judges are facing impeachment proceedings. I may also refer to the infamous incident of ‘cash at door’ in another High Court. Surprisingly, no further action was taken in spite of the report of an in-house committee indicting a sitting judge. I am not prepared to accept that this phenomenon has anything to do with the salary structure of the judges. Salaries of the judges have vastly improved after the VI Central Pay Commission. The problem, according to me, lies with the flawed selection process. Further, the process of impeachment is extremely tedious and has not proved to be effective against erring judges. Perhaps, time has come to devise a new procedure for disciplining judges without in any manner compromising the judicial independence.

Tribunalisation :

BCAJ Do you think that the creation of various tribunals being resorted to by the Government will undermine the quality of the judicial process ? Have the tribunals generally done good work ? Have they reduced the burden on the courts or have they, in fact, become one additional forum for litigation ?

APS In a recent judgment of the Supreme Court in Union of India v. R. Gandhi, the validity of the constitution of National Company Law Tribunal (NCLT) and National Company Law Appellate Tribunal (NCLAT) has been upheld. One of the questions before the Supreme Court was whether the ‘wholesale’ transfer of powers as contemplated by the Companies (Second Amendment) Act, 2002 would have offended the Constitutional scheme of separation of powers and independence of judiciary and to what extent the powers of judiciary and High Court (excepting judicial review under Articles 226-227) can be transferred to tribunals. Though the Apex Court upheld the constitution of the NCLT and NCLAT, further directions were given to the effect that only judges and advocates can be considered for appointment as judicial members. Certain other directions were given protecting the tenure, salaries and perks of the members of the tribunal. As per the direction of the Apex Court, the selection of the members has to be made by a committee presided over by the CJI or his nominee.

The argument generally advanced to support the tribunalisation is that the court functions under archaic and elaborate procedural laws and highly technical evidence law and all litigation in courts can get inevitably delayed which leads to frustration and dissatisfaction amongst litigants. On the other hand, tribunals are free from shackles of the procedural laws and evidence law. They can provide easy access to speedy justice in a ‘cost-affordable and user-friendly’ manner. But, in India unfortunately tribunals have not achieved full independence. The secretary of the concerned sponsoring department sits in the selection committee for appointment. When the tribunals are formed they are mostly dependent on their sponsoring department for funding, infrastructure and even place for functioning. In L. Chandra Kumar, the Supreme Court observed that the tribunals have been functioning unsatisfactorily because there is no authority charged with supervising and fulfilling their administrative requirements. The tribunals constituted under different enactments are administered by different administrative departments of the Central and State Governments.

In R. Gandhi’s case, the Supreme Court has extensively referred to the Leggett Committee Report, which was submitted to the Lord Chancellor of Great Britain in March, 2001. Some of the important recommendations in the report are that the members of the tribunal would be independent persons, not civil servants. They should resemble courts and not bureaucratic boards. There is a need to rationalise and modernise the tribunals by creating more coherent framework for their functioning. All tribunals should be supported by a tribunal service i.e., a common administrative service which would raise their status, while preserving their distinctiveness from the courts. The Supreme Court has urged the Central Government to consider and implement the key recommendations of the Leggett Committee. In the absence of these reforms, the objective of forming these tribunals would not be achieved and, as stated by you, they would be merely one additional forum for litigation.

Arbitration and mediation :

BCAJ In our practice, we see that when a matter is referred to arbitration panel comprising of retired judges, it gets prolonged like a trial in the court itself. Will arbitration in commercial matters by panel comprising of persons who have expertise in the commercial matters be more effective and speedy than the panel of retired judges ?

APS The use of arbitration has taken on staggering proportions in international arena. The full potential of arbitration has not been realised in India. The basic problem lies in the system of ad hoc arbitration. According to critics, many arbitrators are not familiar with the practice of arbitration or how to effectively conduct arbitration process. Lawyers are often not trained in the law and practice of arbitration. There is a tendency among them to prolong arbitrations, seek unnecessary adjournments. One of the critics commented that often retired judges are appointed as arbitrators who, by virtue of long tenure on the Bench, have got accustomed to tedious rules pertaining to procedure and evidence. As a result, arbitrations become battle of pleadings and procedure, with each party trying to stall, if it works to their favour. The Parliamentary Standing Committee’s Report of 2003 highlights that there is absence of accountability of arbitrators, huge pendency of cases, no rules as to who can be appointed as arbitrators or regarding their views, time limit for making an award or consequences of not making an award within the time limit.

The need of the hour is institutionalisation of arbitration in India, along the lines suggested by the Parliamentary Standing Committee Report. The Ministry of Law and Justice has published a consultation paper suggesting extensive amendments to the Arbitration and Conciliation Act, 1996. One of the proposed amendments is to S. 11 whereby the Chief Justice, instead of choosing an arbitrator may choose an institution and such institution shall refer the matter to one or more arbitrators from their panel. As a result of the decision of 7-Judges Bench judgment in SBP Company v. Patel Engineering Limited, the provisions contained in Ss.(4), Ss.(5), Ss.(7), Ss.(8) and Ss.(9) of S. 11 with regard to appointment of arbitrators by any person or institution designated by the Chief Justice rendered totally ineffective. I hope that with the amendment institutionalised arbitration will develop in India.

The Delhi High Court has started an arbitration centre in its own precincts. The endeavour is to create a system that would ensure expeditious disposal of the matters referred to arbitration. The Centre has state-of-the-art infrastructure and elaborate rules have been laid down to govern the mattes referred to it. The panel of arbitrators of the Centre includes not only retired judges but also eminent chartered accountants, engineers, architects, etc. Incidentally, I may also mention that some of the other amendments proposed by the Law Ministry would be able to clear the confusion created by the recent Supreme Court judgments and make the implementation of the Act smooth and effective. Lok Sabha has passed the Commercial Division of High Court Bill, 2005 which provides for constitution of arbitration division in the High Courts to deal exclusively with arbitration cases.

BCAJ Courts, tribunals (e.g., CLB) often informally ask parties to settle the matter by negotiations. Will statutory recognition to this help in reducing the backlog? What can be done to promote and make effective the alternate dispute resolution mechanism ?

APS I fully agree that there is an urgent need to introduce provisions on the lines of S. 89 of the CPC for tribunals like CLB, DRT, etc. S. 89 itself requires an amendment to bring clarity in the process of mediation and conciliation. Mediation and court-supervised mediation in particular, has become more common place in the US and in many countries. The procedure has become increasingly a standard practice. Court-ordered mediation has proved to be a very good way to involve and commit lawyers and participants to the mediation process, because in essence they have no other choice. In the UK penalties in terms of cost can be imposed on parties that refuse to mediate on unreasonable and unsatisfactory grounds. With the active support of the Bench and the assistance of trained mediators, many of the matters can be resolved in CLB or even in DRT.

Right to Information :

BCAJ The RTI Act has been servicing the citizens fairly well. No doubt it has some deficiencies. Huge controversy is on between the Government (DoPT, Ministry of Personnel, Public Grievances and Pensions) and citizens, between Sonia Gandhi and PM and so on. What are your views on this issue ?

APS The right to access the information has been described as a right to citizenship or a right to humanity. All major human right conventions such as UDHR, ICCPR, incorporate specific provisions on the right to information. By a series of decisions of the Supreme Court, (State of UP v. Raj Narain and S. P. Gupta v. Union of India), the right to information is held to be implicit in the guarantee of free speech and expression under Article 19(1)(a) of the Indian Constitution. In a recent decision in Secretary General Supreme Court of India v. Subhash Chandra Aggarwal, the Delhi High Court has held that the right to information is embedded in Article 14 (equality), Article 19(1)(a) (free speech and expression) and Article 21 (life and liberty). The right to know and freedom of information are inalienable components of freedom of expression and participation in public affairs.

Corruption is now recognised as violation of human rights and one of the objectives of right to information is eradication of ineffective and corrupt governance. UNDP has reported decline in ‘Human Development Index’ (HDI) in more than thirty countries, which affects ordinary man. Therefore, it is really necessary that the ordinary man is enabled to participate in the process that affects his daily life and is empowered with the information to play an effective role in policy making and legislative decision making. With access to information, poor people can begin to organise themselves to form groups to be able to influence the decisions that affect them.

Some of the most serious violations of human rights and fundamental freedoms are justified by governments as necessary to protect the national security. It is therefore imperative to enable people to monitor the conduct of the Government to participate fully in democratic society by giving them access to Government-held information and to limit the scope of restrictions of freedom of expression that may be imposed in the interest of national security. Without free access, the common man is likely to feel ‘powerless’, ‘alienated’ and ‘left out’.

Any attempt to dilute the RTI Act must be discouraged. The Government machinery must now learn to live with the information regime.

BCAJ The CJI has been advocating for exemption of judiciary from the application of RTI Act. As per the press reports the CJI has pointed out that the ‘independence of the higher judiciary needs to be safeguarded in the implementation of the RTI Act’. What are your views on this ?

APS Independence of judiciary cannot be separated from judicial accountability. The guarantee of judicial independence is for the benefit of the people and not the judges. It is neither a right, nor a privilege of the judges. An accountable judiciary without any independence is weak and feeble and independent judiciary without any accountability is dangerous. The usual recommendations for increasing accountability in general are not very different for the judiciary than they are for any other public institution. The total transparency in the judicial system can be achieved

(a) by a transparent system of selection of judges, publicised criteria and discussion on their applications, and (b) transparency of internal operations and their subjugation to pre-established rules, use of resources, salaries, judicial standards of behavior and evolution etc. and (c) functional system for registering complaints for institutional operations or behavior of individual trust. As observed by the Delhi High Court, well defined and publicly known standards and procedures complement, rather than diminish, the notion of judicial independence. The former CJI in subsequent interviews clarified that he is not in particular against the application of the RTI Act to the judiciary, but his reservation is only to the disclosure of information relating to the appointments. As stated earlier, the present system of appointments is opaque and shrouded in secrecy, there is need to bring total transparency even in the procedure for appointments to the superior courts.

BCAJ Under the RTI Act, ‘Information’ includes information relating to any private body which can be accessed by a public authority under any other law for the time being in force.

Considering this, can one access documents of public companies, especially public utility companies as ‘information’ ?

APS The term ‘information’ is widely worded and includes information relating to any private body which can be accessed by a public authority under any law for the time being in force. Right to information is defined to mean information accessible under the Act, which is held by or under the control of any public authority. In Secretary General, Supreme Court of India v. Subhash Chandra Aggarwal, the Delhi High Court gave a broad meaning to the word ‘held’ to mean the information which has been created, sought, used or consciously retained by a public authority. Both the provisions will have to be read together and the applicant will not have any right to access the information of any corporations or public utility companies unless it is held by the public authority within the meaning of S. 2(j) of the RTI Act.

BCAJ What changes could be made in RTI Act for furthering its objectives?

APS From the screened system of governance protected by the Official Secrets Act, we have taken more than 70 years to enact the Right to Information Act. We cannot really say it is a voluntary movement towards openness, this is more a reaction to the unstoppable global trend towards the recognition of the right to information. Ideally the Act should also apply to the corporations and MNCs which are engaged in public utility services. NGOs, educational institutions, charitable trusts, and trade unions should be just as accountable and as transparent as the Government in a developing democracy. The involvement of MNCs in human rights violations and generating hazards is well documented. The Bhopal gas tragedy is a glaring example of violation of human rights at the hands of MNCs. Corporations produce wealth; they also produce risk, both to humans and to the eco system. Further the Act provides for sweeping exemptions, there is no mechanism to deter the delay or refusal in granting information, there is no scope for intervention in spreading awareness. . . . . suo moto or proactive duty on the part of the authorities to furnish information, information is given only on demand. Notwithstanding all these, it is a great move towards the access.

Criminal justice system :

BCAJ In criminal matters the conviction rate is said to be rather low. Is it that investigations are shoddy or do we need to review the way courts consider the evidence ?

APS First, let me give some statistics. On an average about 60 lac crimes are registered in each year in the States and Union Territories. 1/3 of these are IPC crimes and the rest are offences under Special and Local laws. Under the CrPC, as it exists today, the investigation of a criminal offence is by the police, whose duties are the maintenance of law and order. The strength of the police force over the years (from 1995 onwards) has remained between 12 and 13 lac, and they are expected to handle virtually unimaginable workload.

In India, not even 45% of the people charged with IPC offences, including mob violence, are ultimately convicted. In other countries like the UK, France, the USA and Japan, the conviction rate for similar offences is over 90%.

Huge number of criminal cases are pending for years together. When they are placed before Magistrates or Sessions Courts at the stage of evidence, due to excessive lapse of time, the witnesses are either dead or have left to some other place or their whereabouts are not known to the prosecution. There are many causes for failure of prosecution and delay is certainly the main cause.

The Malimath Committee’s report has suggested many reforms and although one may not agree with all the recommendations, at least some of them were excellent, but not implemented by the Central Government. For example, the Committee recommended that there should be a separate investigation wing with experienced police officers trained in forensic methods of investigation to be in charge of the investigation, leaving the law and order to be dealt with by a separate and distinct enforcement wing.

Plea bargaining was an important recommendation by the Malilmath Committee, which has been partially accepted but its implementation is far from satisfactory. The Malimath Committee also recommended stringent action against perjury. It has recommended to States for providing more infrastructures to the investigating machinery, especially in regard to accommodation, mobility, connectivity, use of technology, training facilities, etc. It has emphasised that forensic science and modern technology must be used in the investigation, right from the commencement of the investigation. There are some excellent suggestions like representation to victims or if he is dead, to his legal representatives and creating a victim compensation fund. Even after passage of more than ten years, there is not much progress on these recommendations. It is a pity that the much-needed police reforms are not taking place in spite of specific directions of the Supreme Court.

Nirav Shah

LISTED COMPANIES REQUIRED TO INCREASE AND MAINTAIN 25% PUBLIC SHAREHOLDING

Securities Laws

A recent amendment dated 4th June 2010 to the Securities
Contracts (Regulation) Rules, 1957 (‘the Rules’) requires that existing
companies whose public shareholding is less than 25%, shall increase such
holding to that level in a phased manner. For companies seeking listing for the
first time, the initial level of public holding would need to be at least 25%
with one exception discussed later herein.

This amendment is not a major policy change except that it is
one more effort — in the background of consistent earlier failures — to increase
the public holding to 25%. However, one change — and effectively it is a major
change at least in terms of impact on capital markets — is that now even the
government companies would be required to attain and maintain 25% public
holding.

It will have to be seen whether this fresh attempt is
successful in achieving the objective. If it is, a substantial quantity of
equity shares would flow into the market raising funds, as per some reports, of
nearly Rs.2 lakh crores over a period of the next few years. However, as we will
see later on, the provision relating to public shareholding is mentioned at
multiple places and unfortunately this is an amendment of just one provision of
law, leaving others untouched resulting in overlap, contradiction and confusion.

While a detailed historical analysis of this issue may not be
of interest here, generally, it can be stated that the level of public holding
has been the subject of continuous change. At an early stage the level of public
holding required was 60%, then it was 25% and an exception was made for a group
of industries, particularly emerging ones such as software, etc., to allow 10%
public holding. There were also some conditions and exceptions to these
holdings.

Note also that there was a distinction in the provisions for
minimum public holding at the time of public issue and minimum public
shareholding thereafter. The problem gets complicated not only because these
requirements at these two stages were different, but also that the regulators
was different. The initial listing requirement is prescribed by
the Central Government through ‘Rules’, while the continuing listing
requirements are prescribed by SEBI through the listing agreement and other
regulations.

The situation in law and facts today is thus as follows. The
old Rules prescribed initial listing requirements and while it generally
required a minimum initial public issue of 25%, under certain situations, such
issue could be of just 10%. Logically, the provisions of law, though prescribed
by SEBI, should state that after the public issue, the company should maintain
these respective percentages. However, partly on account of changing policies
and partly on account of poor drafting, the requirements of law as contained
particularly in the listing agreement are ambiguous. Essentially, the intention
was that not only the 25/10% public shareholding should be maintained, but that
even those companies who had a lower public shareholding for any reason should
also raise their holding to such percentages. In practice, owing to poor
drafting, poor enforcement, practical problems, keeping exceptions, etc., this
was not achieved.

Thus, to reiterate, the objective of the law-makers was to
ensure that the public holding should be of a reasonable minimum level so as to
serve the purposes of listing. The amended law now provides that this minimum
level is 25% uniformly for all companies. The intention also is that the
ambiguities in the provisions be eliminated partly by better drafting and partly
by simplifying by not allowing any exceptions to this Rule.

In the light of general discussion as above, let us now
consider the amendments made.

(a) The term ‘public shareholding’ is defined and it
would mean the holding of persons other than (i) Promoters and the Promoter
Group (both defined as per the SEBI (ICDR) Regulations, 2009 (ii)
subsidiaries and associates of the company.

(i) The ‘public shareholding’ is intended to be of
equity shares. However, this is not well brought out. The requirements of
initial public issue cover both the issue of equity shares as well as the
convertible debentures, but the requirements of continuing public
shareholding thereafter refer only to equity shares.

(b) At least 25% of all public issues of equity shares
and convertible debentures under an offer document shall be to the public
shareholders.

(i) An exception to the above is that if the post-offer
market capitalisation calculated with reference to the offer price is at
least Rs.4000 crores, then a 10% issue is sufficient. However, even such
companies would be required to increase the public shareholding to at
least 25% in a phased manner, with at least 5% every year till this 25% is
reached.

(c) All existing listed companies are required to
maintain 25% public shareholding. Those companies that do not have such
minimum 25% public shareholding are required to increase the public
shareholding by at least 5% every year till such 25% public shareholding is
reached. Thus, the intention is that within a maximum period of 5 years, all
companies should have at least 25% public shareholding.

(d) The provision enabling exceptions to be made for
government companies has been omitted. This is a significant amendment. As
per some press reports, to achieve 25% public holding, almost 85% of the
fresh issue of shares would be by the ‘government companies’.

A clear time frame to achieve 25% public shareholding has
been prescribed. However, what happens if the company does not comply with such
requirement for any reason ?

(i) There is no specific provision in the Securities
Contracts (Regulation) Act, 1956, dealing with violation of this new Rule 19A.
It appears that the following could be the consequences :

A
penalty of up to Rs.1 crore.

Imprisonment up to 10 years or a fine up to Rs.25 crores or both.

Suspension of listing/delisting may also be possible.

(ii) Of course, the usual provisions governing
penalty/prosecution would apply. For example, the facility of compounding of
the violation would be available.

Now let us see some of the concerns with regard to the
amendment.

A major puzzle is that the provisions of Clause 40A of the listing agreement have not been repealed/ modified. It can be seen that this is the provision, howsoever defective, that specifically deals with requirement of increasing the public holding to the specified levels. As can also be seen, this Clause is plainly contradictory with the new requirements. For example, the new requirement requires all companies to maintain/increase their public holding to a common 25%, while Clause 40A has many exceptions. In fact, the scheme of the law till now was simple that is the Rules dealt with ‘initial listing’ while ‘continuing listing’ was dealt with by the listing agreement. However, now there is overlap that does not serve any purpose. While one could technically take a view that a later provision of law overrides an earlier one, this can hardly be a happy approach to take either for the company or even for SEBI.

Unlike the existing Clause 40A, there is no provision for an exception or extension. No exception is given to any type of company. No power is also given to SEBI or the stock exchanges to make any exception or granting any extension to the time schedule for raising public holding.

A major concern is how can the public shareholding be increased?? What are the permissible methods — or, to put it the other way, are any methods prohibited?? SEBI has been authorised to specify the manner in which the public shareholding shall be increased. The common methods may be a fresh public issue, offer for sale by the Promoters, offloading of shares by Promoters in the open market or through off-market deals, etc. One will have to wait for SEBI to prescribe these methods.

The scheme of having a minimum public shareholding has to be built in not only in the Rules and the listing agreement but also in other provisions of law such as the ‘Takeover Regulations’. These will also need amendment to achieve 25% public shareholding.

For the record, it may be recollected that the definition of ‘public’ itself was criticised. It was stated that the inclusion of FIIs, etc. in public effectively resulted in the net holding of the remaining ‘actual public’ to be quite small. Thus, removing such entities from this category was seriously considered. However, no such exclusion has been made and thus holding of FIIs, NRIs, FIs, etc. would be included in ‘public’ shareholding.

It is seen from various published reports that basically companies that would be affected would be the large government companies. In fact, these reports estimate that almost all of the issues in terms of amount would come from such companies. However, it is also true that such companies have not always been found to be wholly compliant with listing requirements. For example, many of government companies have not yet complied with the requirements of ‘corporate governance’. SEBI

has actually passed orders recording this and while it has not awarded any punishment, the orders have highlighted the plight of companies which are effectively at mercy of the government.

Companies that made a public issue of 10% in recent years can rightly air a grievance that had they known that they would be required to make a 25% public issue, they would not have made a public issue in the first place. I think this is a serious and a fair concern and an exception would have to be made for such companies. Having made a public issue of, say, 10%, they can now neither stay, nor exit easily without causing problems to many. To put it simply, they cannot delist and they cannot dilute?!

In conclusion, it appears that unless the new provision is strictly implemented and enforced, it would be merely another half-hearted paper attempt. Newspapers are already reporting that the Finance Ministry is considering tweaking with the new rules. If this happens, it will be another instance of lack of co-ordination between the Government and the Regulator, and perhaps yet another attempt and opportunity going waste.

Nirav Shah

Delisting of Shares — The newly notified regulations

Securities Laws

1) SEBI has, on 10.6.2009, notified new Regulations
relating to delisting of equity shares of listed companies. Essentially, they
provide for a detailed procedure for delisting and certain safeguards for public
shareholders. The new Regulations replace the earlier SEBI Guidelines of 2003.

2) The Regulations provide for different ways in which
delisting can take place. The most common one would be where it is voluntary and
initiated by the company and the promoters. Then there is a fast track but,
again, voluntary, delisting of defined ‘small’ companies. Under certain
circumstances, there can also be compulsory delisting. Finally, there are
residuary cases such as of BIFR companies, companies in winding up, etc.

3) Delisting means removal of listing of equity shares from
recognised stock exchanges. Thus, shareholders do not have any more a ready
market for their shares. Almost all shareholders — at least all the public
shareholders — buy shares on the assurance that there is continued listing.
Indeed, at the time of a public issue, the law requires that if listing does not
take place soon thereafter, the monies raised have to be refunded.

4) Listing provides significant advantages. There is a ready
market for the shares and this itself adds to the intrinsic value of a share.
Ready market provided by listing results in a better price since there are more
persons competing to buy the shares. Such wide and ready market also adds
further value to the shares on account of sheer liquidity whereby share-holders
can get virtually instant cash by selling their shares.

5) Listing is obviously advantageous to the company too as
funds can be raised easily and at a relatively lesser cost. However, the flip-
side is that there can be considerable costs and inconvenience requiring
compliance with SEBI requirements and corporate governance regulations. Hence,
companies look at delisting as an option. There are also many other reasons for
the company to consider delisting.

6) Considering space constraints, we would consider here
mainly, and even that too briefly, the Regulations where Promoters initiate
delisting.

7) Under the new Regulations, the procedure for voluntary
delisting is even more complicated and costly than earlier. It can be summarised
as follows :

a) The first step is taking approval of the Board and then
of the shareholders. There are 3 special features to be noted for the
shareholder approval. Firstly, the approval is required through postal ballot,
thus ensuring wide participation of share-holders. Secondly, the approval
needs a special resolution. Thus, at least 75% of those who vote have to vote
in favour of delisting. Finally, of the votes cast by public shareholders, at
least 2/3rds have to vote in favour. This is a new and interesting requirement
as it ensures potentially unfair and unpopular delisting proposals get nipped
in the bud.

b) The next step is taking in principle approval of stock
exchanges. This step will ensure that the broad feasibility of the proposal of
delisting would be tested relatively early. In fact, it could have been the
first step to ensure a basic test. The application has to be disposed of
within 30 days of receiving an application complete in all respects.

c) Then, the Promoters have to initiate the exit offer to
public shareholders within one year of the special resolution. This means that
the Promoters have to offer to buy shares of the public shareholders. ‘Public
shareholders’ means essentially share-holders other than the Promoters. This
is a sensible requirement as it allows the public shareholders to get their
monies rather than get stuck with illiquid shares.

The ‘offer price’ has to be at least the ‘base price’ that
is derived by a formula that takes into account quoted prices of the recent
past. However, this price is fortunately not binding. With this price as the
base, a procedure of book building is initiated where the public shareholders
quote the price at which they are willing to sell. If the prices and
quantities offered are such that the Promoters are willing and able to buy
either 50% of the total public holding or increase their holding to at least
90%, and they agree to do so, then the delisting is successful. If not, the
process fails.

d) However, it does not mean that the remaining
shareholders find their shares irrevocably illiquid. The Regulations require
that the Promoters should, over a further period of at least one year, buy the
remaining shares, if offered, at the same price.

• Using the
market price as benchmark for the offer price is defective and unfair to the
shareholders. Listing gives a signifcant premium to the shares. Conversely,
news of delisting results in the quoted price reaching nearer to the value
of an unlisted share. Since the formula for the base price relies on quoted
prices, the shareholders are thus deprived of a fair price.

e) In ‘book building’, there is obvious scope for
manipulation by both sides. The Promoters may line up some friendly public
shareholders to reach any one of the magic cut-off limit as above. On the
other side, shareholders may be tempted to ask for unduly high price and even
rigging and cartelisation has been alleged frequently in the past. There is no
downside for them obviously since even if they fail and if there are enough
shareholders offering a lower price, they can always get this price over the
next one year as the Regulations require the Promoter to keep the offer open
for another one year. Of course if too many shareholders do this, the
Promoters may simply exercise their option to withdraw.

f) SEBI has attempted to make the process fair and free of
manipulation. In particular, there are specific provisions providing that
there is no manipulation, fraud, deceit, etc. in the process by the Promoter
or any person.

8) Fast-track delisting of ‘small’ companies :

a) Special provisions are made for ‘small’ companies satisfying certain conditions and a relatively faster process is provided for delisting of shares of ‘small’ companies.

b) The basic benefit given is that the elaborate procedure for giving an exit offer would not apply and while such an exit offer still needs to be given, a faster and simpler procedure is provided for.

c) Small companies for this purpose would mean two types of companies :

In the first type, there would be a company with a paid-up capital up to Rs. 1 crore and whose equity shares were not traded at all in any recognised stock exchange in the preceding one year.

In the second type, there are 300 or lesser number of public shareholders and the paid-up value of shares held by such public shareholders does not exceed Rs. 1 crore.

d) Instead of the elaborate procedure for exit offer, a shorter process is provided for. An exit offer price is determined in consultation with a merchant banker. The offer is conveyed to the public share-holders. 90% of the public shareholders (Regulations are not clear but presumably 90% refers to value and not the number of public shareholders) need to agree either to sell their shares at the offer price or to continue to remain shareholders post-delisting. The offer document would also state that their agreement also includes an agreement to waive the book-building process for price-discovery.

9) Compulsory delisting :

a) Certain grounds for compulsory delisting may be prescribed by rules made pursuant to Section 21A of the Securities Contracts (Regulation) Act, 1956. Needless to add, there would need to exist strong grounds to do this and where the continuance of listing may be found to be more harmful than delisting and consequent loss of market for the shares.

b) Apart from existence of such serious grounds, the decision for compulsory delisting is to be taken by a panel of the stock exchange, consisting of 5 members including a representative of small investors.

c) Compulsory delisting does not mean that the Promoters escape the requirement of buying out the public shareholders. A fair price of the shares is worked out and the Promoter is required to pay such price to the public shareholders to acquire their shares. The Regulations do not provide for a time limit for carrying out such purchase. That apart, the Company, its Promoters and all companies promoted by them, and whole-time directors would be debarred from accessing the capital market or seek listing of their shares for ten years after delisting. One wonders, though, whether this requirement can be enforced in practice since typically the Promoters of companies facing such serious charges may default even on these further requirements.

Poser: Whole-time director could be an employee holding stock options or having a small holding, who could change his job. How will this requirement impact him and the company he joins?

10. Miscellaneous provisions and points:

a) Two stock exchanges – BSE and NSE for now – are specified as nationwide stock exchanges. If delisting is sought from other than these and where listing continues on one or both of such exchanges, the process is simpler and, importantly, the require-ment of making an exit offer is waived.

b) If delisting is pursuant to a scheme sanctioned by BIFRand if such scheme lays down the procedure for delisting or provides for an exit option to the public shareholders, then the Regulations shall not apply.

c) A minimum period of 3 years should have passed after listing before an application can be made for delisting.

d) A peculiar feature of the Regulations is that the exit offer is required to be given by the Promoters. No funds of the Company shall be used directly or indirectly. Buyback of shares as a means of delisting is specifically prohibited. This is strange and even absurd. Delisting is the reverse of listing. In case of listing, usually, it is the Company that issues shares to the public and receives monies for such issue. In case of delisting, the process ought to be the opposite – the Company should repay the monies back to the shareholders. If, during listing, the Promoters do not get any money, how can they be expected to raise money to buyout the public shareholders? Also, delisting does not recognise a professionally managed company where. there are no Promoters. Does that mean that shares of such companies cannot be voluntarily delisted ?

e) Under the exit offer, the Promoter is required to place 100% of the minimum offer consideration in escrow in cash by way of bank guarantee. Even after buying out the shareholders who offer their shares in the first round, the Promoter will need to maintain the escrow to provide for the remaining shareholders who have option to offer for a period of one year. This is sensible new requirement but, for the Promoters, this results in blocking of funds or maintenance of bank guarantee for one year.

Conclusion:

a) Reading the Regulations, one wonders whether SEBI thinks complexity is equivalent to comprehensiveness. While many provisions are made in enormous detail, some principle and vital issues are ignored. The pricing formula continues to be unfair as Promoters can literally offer the shareholders the option of the proverbial devil and deep sea – either accept the offer price or get your shares delisted (even the middle ground of rejection of delisting suffers from the company’s shares being under the stigma of potential delisting and thus quite possibly under-quoted). On the other side, forcing the Promoters to raise funds from outside the Company for delisting is inappropriate and is a breeding ground of corruption. The Regulations also effectively punish compliant companies making them undergo the elabora te procedure and payment for the exit offer while ‘vanishing’ companies escape both the procedure as well as the payment. Thus, while one recognises the thoughtful small touches at many places, the Regulations, that have come after more than a decade of consideration, disappoint as a whole.

Nirav Shah

Public Issue of Securitised Instruments — the new SEBI Regulations

Securities Laws

This series of articles introducing securities laws for
listed companies to the lay reader continues . . .

(1) Background :

(a) SEBI has finally notified the regulatory scheme for
public issue and listing of securitised instruments. While we will review these
Regulations later herein, it is worth considering, very briefly, the background
of ‘securitised instruments’.

(b) The Securitisation and Reconstruction of Financial Assets
and Enforcement of Security Interest Act, 2002 (often referred to as SARFESI Act
or, simply, the Securitisation Act) is known more for the powers that
particularly institutional lenders are given under this Act to recover their
dues. The other half of this Act is securitisation of assets.

(c) While I am sure that readers are familiar with this term,
a quick description of securitisation may be worthwhile. To take a typical
example, a lender may have debts of various kinds arising out of loans granted
by it. The debts may be payable over a long period of time.. For rotation of
these funds or for other reasons, the lender may want to assign these debts to a
buyer who then simply collects the debts. Such buyer, in turn, may be a person
with his own money or, more often, raises monies from investors who may be
interested in relatively safer returns. This process can be loosely
referred to as securitisation. Effectively, securities are issued to the
investors towards their interests in the debt so bought.

(d) The buyer may invest his own money or raise monies from
private investors. However, a bigger source of money may be the public for
various reasons. Firstly, the public may be interested in safe returns from
securities. The returns may be relatively higher than other instruments.
Properly securitised and issued in small amounts, such instruments may become
attractive to the public. However, issue to the public requires necessary legal
provisions of investor protection and it is at this stage SEBI steps in. SEBI
has to ensure that the process of issue to the public of such instruments is
transparent, with full and fair disclosures and after the issue, the interests
of the investors are safeguarded. Also, the monies received are managed by
registered intermediaries.

(e) Thus, SEBI has recently, on 26th May 2008, notified the
Securities and Exchange Board of India (Public Offer and Listing of Securitised
Debt Instruments) Regulations, 2008 (‘the Regulations’) which contain very
detailed provisions relating to issue and listing of such instruments. It is
worth reviewing these new though quite specialised Regulations.

(2) Scheme of the Regulations :

(a) The Regulations seek to make comprehensive provisions
relating to the formation, constitution and structuring, etc. of an entity
issuing securitised instruments, called ‘Special Purpose Distinct Entity’ (‘SPDI’)
in the Regulations. The Regulations provide for : How and in what form would
such a SPDI be formed and structured, what type of Securitised Debt Instruments
(‘SDI’) they can issue, what would be the disclosures, and how it would be
managed, etc.

(b) The structure of SPDI can be loosely compared with the
structure for mutual funds though SPDI seems to have lesser flexibility. SPDIs
and instruments issued by them are comparable with mutual funds in the sense
that the investments are made effectively on behalf of the unit holders and
managed by persons on behalf of such investors. The essential difference is that
these Regulations focus on a very specialised type of securitisation and hence
make very specific requirements for them.

(c) It would be also worth describing the process involved in
the securitisation of debt and thereafter making a public issue of SDI and
related matters. There would be a Sponsor who would establish an SPDI. The SPDI
has to be in the form of a Trust. There would be Trustees who would manage the
SPDI and carry out other related functions. There would be an Originator who
assigns certain debts to the SPDI. The SPDI would then issue the SDI to the
public under a Scheme and then list such SDI on the stock exchange. The SPDI
would then collect dues in respect of the debts so acquired and distribute such
monies, after deducting costs, to the investors. The investors, in turn, may
hold the SDI and enjoy the steady returns or they may at any time sell the SDI
on the stock exchange at which they are listed at the prevailing market price.
The Scheme would come to an end normally when all the debts are recovered and
the investors are fully paid off.

(d) With this very broad overview of the Regulations, let us
look at some interesting aspects of the Regulations.

(3) Trustees :

(a) The Trustees have perhaps the greatest of responsibility
under the Regulations. They have to take great care while acquiring the
specified debts and particularly ensure that these debts are recoverable,
enforceable and also assignable to SPDI. They have to make the requisite
disclosures in the offer document. They have to manage the debts and recover
them and distribute the proceeds to the investors. They have personal and direct
responsibility in case of contraventions. Having said that, though the
responsibilities cannot be understated, it also appears that each of these
obligations is not absolute, but the intention is more of preventing negligence
and fraud. If, for example, there are bad debts beyond the control and
reasonable foresight of the Trustees, they would not be held
responsible.

(b) Interestingly, the Trustees need not necessarily be Trustees registered as such intermediaries with SEBI.However, they would require to be registered with SEBI under these Regulations if they are not so registered otherwise as Trustees. Certain other entities would also not require such registration under the Regulations. Thus, a person can get himself registered as a Trustee under these Regulations and qualify to manage the SPDI.The Trustee can also be a corporate entity.

(c) The requirements of registration under these Regulations are elaborate and are similar to registration of other intermediaries.

(4) Debts or receivables that can be acquired:

(a) These would be the core assets of the SPDI just as shares and other specified securities are the core assets of mutual funds. However, the definition of these debts that can be acquired by SPDI is quite narrow and would include items such as mortgage debt, financial assets as defined in the Securitisation Act, etc.

(5) SPDI:

(a) This is the entity, a Trust, that would acquire debts and issue securities to investors. The SPDI has to be quite specialised – in fact, it practically cannot do any other activity except of securitisation. The reason is obvious. The objective is to acquire a chunk of debts and then issue instruments to investors representing an appropriate interest in these debts. The SPDI would then only manage and recover these debts. If it does any other activity, and if there is any loss, the investors would suffer since the loss would go to reduce the debts. However, certain passive investment of surplus monies is, for example, allowed.

(b) There is an entity termed ‘Servicer’ who can do/be given the job of collecting the debts and distributing the proceeds to the investors. Strangely,it is not required that such ‘Servicer’ should be a registered intermediary. In my opinion a person who could be given the control of all the assets of the SPDI for collection and even the further distribution to the investors should be registered with SEBI for proper control.

(6) Scheme:

(a) As in the case of mutual funds, the SPDI can frame schemes pursuant to which it can issue SDI to the investors. Thus, there can be multiple schemes. This also means that recovery of one lot of debts and repayment in full to the investors would not mean the end of the SPDI itself.The SPDI can issue securities under another scheme. In fact, it can issue securities under multiple schemes. Again, quite obviously, each of the schemes would have to be kept segregated in all respects.

(b) Each scheme would have its own disclosures ~ and features which would have to be complied with regard to that particular scheme.

(7) Accounts and Audit:

(a) The SPDI would be a Trust and thus would not be subject to the normal requirements of accounts and audit as, for example, companies are subject to. Thus, the Regulations make specific though quite general and broad requirements relating to accounting and audit. The Regulations also require compliance of Guidance Notes issued by the Institute of Chartered Accountants of India.

(8) Dematerialisation:

(a) The SDI issued should be capable of dematerialisation. However, at the option of the investor, securities in physical form can also be issued.

(9) Credit rating:

(a) Where the core assets are debts, credit rating is required as this helps in the assessment of the risk being assumed by the investor.

(b) The SPDI would have to obtain at least two credit ratings. Interestingly, it will have to disclose all the credit ratings obtained by it and not just the ones it found acceptable. Thus, the SPDI can go shopping for credit ratings, but SPDI will have to disclose all the ratings received.

(c) Having said that, no minimum credit rating has been prescribed for the issue of SDI as for example is the case in case of deposits issued by NBFCs. Apparently, the objective may be that it would be up to the investor to balance the credit rating received with the return expected and take his decision accordingly. Hence, in line with the logic of the above, no maximum rate of return is prescribed as so provided for NBFCs.

(d) The credit rating would have to be reviewed periodically, but not later than a period of one year from the previous rating.

(10) Miscellaneous provisions:

(a) There are elaborate provisions for inspection of the accounts, records, etc. In case violations are found, there are specific provisions in the Regulations themselves. Further the general provisions in the SEBI Act and the Securities Contracts (Regulation) Act to penalise the violations would also be applicable.

(b) There are provisions relating to minimum sub-scription, underwriting, etc. which are conceptually similar to the public issue of securities.

(c) The SDI would have to be listed and where they are not listed, the amounts raised would have to be refunded. However, it appears that no time limit is specifically provided for the time within which the SDI should be listed.

(11) Conclusion:

(a) One could argue that SEBI has been proactive in issuing regulations even when the instrument is not popular – for example – the regulations relating to buyback were issued in 1998and they were barely used for some years. Presently, the global economy is suffering from the sub-prime crisis and securitised assets are said to be the major culprit. Hence, perhaps investors may be frightened of such assets. Having said that, securitised instruments offer an otherwise well-developed alternative to investors for investments. I am sure that sooner or later these instruments will gain popularity in India.

(b) The Regulations also show a level of maturity in the sense that many of the problems faced by SEBIover the past few years have been addressed. Of course, this is perhaps another reason that the Regulations are unduly complex! The coming years will show the fate of the innovative and sophisticated instruments. In India it will be a learning experience for both the investors and their advisors and of course for the auditors.

Nirav Shah

Foreign investment in India by SEBI registered Long term investors in Government dated Securities

Presently, SEBI registered Foreign Institutional Investors (FII), Qualified Foreign Investors (QFI) and long term investors can purchase, on repatriation basis, Government securities up to US $ 25 billion and non-convertible debentures (NCD)/onds issued by an Indian company up to US $ 51 billion.

This circular has increased the limit for investment in Government securities by US $ 5 billion from US $ 25 billion to US $ 30 billion. This additional limit of US $ 5 billion is available to long term investors registered with SEBI viz. Sovereign Wealth Funds (SWFs), Multilateral Agencies, Pension/ Insurance/ Endowment Funds, Foreign Central Banks.

levitra

Nirav Shah

A. P. (DIR Series) Circular No. 110 dated June 12, 2013

Foreign Direct Investment – Reporting of issue/ transfer of Shares to/by a FVCI

Presently, transfer of equity shares/fully and mandatorily convertible debentures/fully and mandatorily convertible preference shares (hereinafter referred to as ‘shares’) of an Indian company, from a nonresident to a person resident in India (resident) or vice versa, has to be reported to RBI, through the bank, within 60 days of the transaction. Also, receipt of consideration for issue of shares of an Indian company, to a non-resident has to be reported to RBI, through a bank, within 30 days from the date of receipt.

This circular has amended Form FC-GPR & Form FC-TRS by inserting the following remarks in para 3(4) and 5(a)(4) of form FC-GPR and para 4(4) and para 5(4) of form FC-TRS: –

‘The investment/s made by SEBI registered FVCI is /are under FDI Scheme, in terms of Schedule 1 to Notification No. FEMA 20 dated 3rd May, 2000.’ This circular also clarifies that whenever a SEBI registered FVCI acquires shares of an Indian company under FDI Scheme in terms of Schedule 1 of Notification No. FEMA 20/2000-RB dated 3rd May, 2000 such investments have to be reported in form FC-GPR/ FC-TRS only. When investment is made in terms of Schedule 6 of the Notification No. FEMA 20/2000-RB dated May 3, 2000 no FC-GPR/FC-TRS needs to be filed. Such transactions have to be reported by the custodian bank in the monthly reporting format as prescribed by RBI from time to time.

Annexed to this circular are the revised forms FCGPR and FC-TRS.

A. P. (DIR Series) Circular No. 111 dated June 12, 2013

levitra

Nirav Shah

Amount paid towards domain name registration, server charges for web hosting are not payment towards technical services

New Page 2

12 M/s. Millenium Infocom Technologies Ltd.
v. ACIT

21 SOT 152 (Del.)

S. 40(a)(i), S. 9(1)(vi)/S. 9(1)(vii), 195;

India-USA Treaty Article 26(3)

A.Y. : 2001-02. Dated : 31-1-2008

Issues :

l
Amount paid towards domain name registration, server charges for web hosting
are not payments towards technical services. There is no withholding
obligation u/s.9(1)(vii) or u/s.9(1)(vi) as it subsisted for A.Y. 01-02.

l
Even if there is default of TDS, there can be no disallowance u/s.40(a)(i) for
non-deduction of tax at source in view of provisions of non-discrimination
Article of the Treaty.

l
The assessee who has remitted funds without tax deduction by obtaining
requisite certificate of a CA and by following CBDT-laid down procedure cannot
be faulted with for not obtaining prior NOC of the AO u/s.195(2).

Facts :

The issue in appeal was disallowance u/s.40(a)(i) for alleged
failure of the assessee of not deducting tax at source in respect of amounts
remitted for registration of domain name and for server charges. The assessee
had remitted the amounts after obtaining requisite certificate of a Chartered
Accountant.

The AO was of the view that the services obtained by the
assessee in the form of domain registration and in the nature of access to
server space were technical services chargeable to tax in India u/s. 9(1)(vii)
of the Act.

Before the Tribunal, the assessee contended that the amount
paid towards server space was in the nature of lease rental and was not for
obtaining any services. The assessee himself had contended that the amount would
be equipment royalty if regard be had to amendment made to the definition of
royalty effective from A.Y. 2002-03.

The assessee also relied on provisions of non-discrimination
Article of the Treaty to contest disallowance u/s.40(a)(i). In the view of the
assessee, Article 26(3) of India-USA Treaty did not permit disallowance of
expenses in respect of payment made to US resident merely because of failure of
the payer (assessee) to deduct tax at source, since parallel payment made to
resident without deduction of tax at source would not have triggered
disallowance for the payer.

The assessee also claimed that since remittance was supported
by suitable NIL TDS certificate of CA obtained in terms of procedure laid down
in CBDT Circulars, it was not imperative for it to have obtained prior NOC
u/s.195(2).

Held :

The Tribunal accepted the contentions of the assessee and
held as under :

Relying on the decision of the Madras High Court in
Skycell Communications Ltd. v. DCIT, (2001) (251 ITR 53) (Mad.), it was held
that payment made for hosting of website and access of server was not fees for
technical services.

Referring to Model commentaries, it was concluded that the
server on which the website is stored and through which it is accessible is a
piece of industrial equipment. Having noted that, the Tribunal referred to
amended definition of royalty u/s.9(1)(vi) (as applicable from A.Y. 2002-03) and
concluded that rent paid for hosting of website on servers was for use of
commercial and scientific equipment and was therefore royalty. The Tribunal
noted that the amended definition was applicable from the subsequent year and
hence the amount was not chargeable as royalty income for the year under
reference.

The Tribunal noted in detail self-certification procedure
laid down by various CBDT Circulars which replaced the need of obtaining
authorisation of the AO for making remittance to a non-resident. Having noted
the contents of various CBDT Circulars and after referring to the decision of
Supreme Court in the case of Transmission Corporation of AP Ltd. v CIT,
(1999) (239 ITR 587) (SC), the Tribunal concluded as under :

“Even in the cases where lower tax has been deducted or no
tax deducted, the assessee by filing an undertaking before the RBI (addressed
to the assessing officer) has made himself liable not only for payment of tax
on such remittances, but also for penalty and prosecution for the defaults
committed by him for non-deduction or lower deduction of tax at source. The
contention of the Ld DR by placing reliance on the decision of the Hon’ble
Supreme Court in the case of Transmission Corporation of Andhra Pradesh
Limited (supra) that the assessee was under an obligation to make
application to the Assessing Officer u/s.195(2) of the Act for the
determination of income and tax to be deducted, in our view, holds no water,
as it runs contrary to the Circulars issued by the CBDT.”

Relying on the decision of Herbalife International India
(P) Ltd. v. ACIT, (2006) (101 ITD 450), the Tribunal also accepted the
assessee’s contention that no disallowance can be made having regard to
non-discrimination provisions of Article 26(3) of the treaty, irrespective of
whether or not the assessee theoretically had obligation of deducting tax at
source.

levitra

Nirav Shah

Exemption u/s. 10A: A. Ys. 2002-03 and 2003-04: Current losses as well as brought forward losses of the non-EPZ unit cannot be deducted or reduced from the profits of the EPZ unit for computing the deduction u/s. 10A:

CIT vs. Tei Technologies (P) Ltd.; 259 CTR 186 (Del):

In the relevant years, the assessee claimed exemption u/s. 10A, 1961 by computing the exempt amount without setting off the loss of non eligible units. The Assessing Officer computed the amount after setting off the loss from the non -eligible units against the profit of the eligible units. The Tribunal allowed the assessee’s claim.

On appeal by the Revenue, the Delhi High Court upheld the decision of the Tribunal and held as under:

“i) Even after the amendment by the Finance Act, 2000, section 10A has been retained in Chapter III of the Act, notwithstanding the change in the language of s/s. (1) thereof. Secondly, though s/s. (1) provides for a deduction of the eligible profits, it further states that the deduction “shall be allowed from the total income of the assesee”.

ii) Determination of total income is the last point before the tax is charged, and once the total income is determined or quantified, there is absolutely no scope for making any further deduction. If this is the true legal position, it is not possible to understand s/s. (1) of section 10A as providing for a “deduction” of the profits of the eligible unit “from the total income of the assessee”. The definition of the expression “total income” given in section 2(45) cannot be imported into the interpretation of s/s. (1) having regard to the context in which it is used and the scheme of the Act relating to the charge of tax.

iii) The form of the return of income prescribed by the Rules gives a further indication that section 10A provides for an exemption and not merely a deduction. Steps given in the return form ITR-6 are also an indication that the relief u/s. 10A has to be given before the adjustment of the losses of the current year and the brought forward losses from the past years.

iv) Incomes which are enumerated in Chapter III have traditionally been considered as incomes which are exempt from tax rather than as deduction in the computation of total income. The fact that a particular class of income is only partially exempt from taxation does not necessarily mean that it is only a deduction. Admittedly, there is ambiguity and lack of clarity or precision in the language employed in section 10A(1) which says that deduction shall be made from the total income, when the Act contains no provision to allow any deduction from the total income.

v) Thus, it is not impermissible to rely on the heading or title of Chapter III and interpret the section as providing for an exemption rather than a deduction even after the amendment by Finance Act, 2000 w.e.f. 01-04-2001.

vi) S/s. (4) of section 80A cannot defeat such construction. Sole object of s/s. (4), is to ensure that double benefit does not enure to an assessee in respect of the same income, once u/s. 10A or 10B or under any of the provisions of Chapter VI-A and again under any other provisions of the Act. This s/s. does not militate against the view that section 10A or section 10B is an exemption provision.

vii) Contents of Circular No. 5 of 2010 dated 03-06- 2010, accord with the aforesaid view. Therefore, the current losses as well as brought forward losses of the non-EPZ unit cannot be deducted or reduced from the profits of EPZ unit for computing the deduction u/s. 10A.”

levitra

Nirav Shah

Charitable trust: Certificate u/s. 80G(5): Amendment by Finance Act (No.2) of 2009 and Circular Nos. 5 and 7 of 2010 issued by CBDT: Certificate once granted operates in perpetuity: Withdrawal, if any, should be as per the procedure:

CIT vs. Bhhola Bhandari Charitable Trust: 259 CTR 279 (P&H):

The assessee, a charitable trust was granted certificate u/s. 80G(5), which was valid upto the F.Y. 2010-11 ending 31-03-2011. The assessee filed an application for renewal on 25-04-2011 which was withdrawn on 30-05-2011 in view of the amendment by Finance Act (No. 2) of 2009 and Circular Nos. 5 of 2010 and 7 of 2010 wherein it was stated that the Certificate granted u/s. 80G(5) which is existing on 01-10-2010 would continue till perpetuity unless it is withdrawn as per law. However, CIT passed order dated 05-12-2011 withdrawing the certificate. The Tribunal set aside the said order.

On appeal by the Revenue, the Punjab and Haryana High Court upheld the decision of the Tribunal and held as under:

“i) We find that the order of the Tribunal setting aside the order of CIT is based on sound reasoning. The assessee had valid exemption on 01-10-201, when the provisions of section 80G of the Act were amended so as to dispense with the periodic renewal of the exemptions. Such statutory provisions were clarified by Circular No. 5 of 2010 and Circular No. 7 of 2010 issued by the CBDT. Once the statute has given perpetuity to the exemptions granted u/s. 80G(5) of the Act, the same could not be withdrawn without issuing show cause notice in terms of the statutory provisions in the manner prescribed by law.

ii) In view of the said fact, we do not find that any substantial question of law arises for consideration.”

levitra

Nirav Shah

Charitable trust: S/s. 11(1)(d) and 80G(5): A. Y. 2005-06 to 2007-08: Certificate u/s. 80G(5); Refusal to continue on the ground that the conditions u/s. 11(1)(d) not satisfied: Refusal not proper: Department directed to pay Rs. 1,00,000/- to the trust:

DIT (Exemption) vs. Sri Ramakrishna Seva Ashram: 258 CTR 201 (Kar):

The assessee, a charitable trust, was registered u/s. 12A of the Income-tax Act, 1961 in May 1991 and was allowed exemption u/s. 11 of the Act since then. A certificate u/s. 80G(5) of the Act was also issued to the assessee trust. The assessee’s application dated 02-02-2009 for continuation of certificate u/s. 80G was rejected on the ground that the donations to the rural project fund are not corpus donations, as such, the same are not credited to corpus account. No details of the donors is furnished in spite of the specific directions. Such donations have not been considered for computation of 85% application u/s. 11(1) of the Act for the A. Ys. 2005-06 to 2007-08. The Tribunal allowed the assessee’s appeal and directed the DIT(Exemption) to grant continuation of the 80G certificate.

On appeal by the Revenue, the following question was raised before the Karnataka High Court:

“If the assessee receives contributions for charitable purposes and does not show them in the statement of account as the ‘corpus fund’, but, shows the said amount under a different specific head, does it cease to be a corpus fund to be eligible for the benefit u/s. 11(1)(d) of the Act.?”

The High Court upheld the decision of the Tribunal, dismissed the appeal filed by the Revenue and held as under:

“i) The word ‘corpus’ is used in the context of IT Act. This can be understood in the context of a capital opposed to expenditure. It is a capital of an assessee; a capital of an estate, capital of a trust; a capital of an institution. Therefore, if any voluntary contribution is made with a specific direction, then it shall be treated as the capital of the trust for carrying on its charitable or religious activities. Then such an income falls u/s. 11(1)(d) and is not liable to tax. Therefore, it is not necessary that a voluntary contribution should be made with a specific direction to treat it as corpus.

ii) If the intention of the donor is to give that money to a trust which they will keep in trust account in deposit and the income from the same is utilized for carrying on a particular activity, it satisfies the definition part of the corpus. The assessee would be entitled to the benefit of exemption from payment of tax levied. From whatever angle it may be seen, the deposited amount cannot be said to be income in the hands of the recipient trust.

iii) Similarly, the assessee after receiving the amount keeps the amount in deposit and only utilises the income from the deposit to carry out the charitable activities, then also the said amount would be a contribution to the corpus of the trust and the nomenclature in which the amount is kept in deposit is of no relevance as long as the contribution received are kept in deposit as capital and only the income from the said capital which is to be utilised for carrying on charitable and religious activities of the institute/corpus of the trust, for which section 11(1)(d) is attracted and the said income is not liable to tax under the Act. In so far as the argument that the person who made these contributions do not specifically direct that they shall form part of the corpus of the trust is concerned, it has no substance. In view of the language employed in section 11(1)(d), the requirement is that the voluntary contributions have to be made with a specific direction. The law does not require that the said direction should be in writing. In the absence of the direction in writing, the only way that one can find out whether there was a specific direction and to find out how the money so paid is utilised. If the money so received by way of voluntary conrtributions, if it is meant to be used for the leprosy patients and is credited to a particular account and from the income from the said capital, the said activity is carried on, the requirement of section 11(1)(d) is complied with.

iv) In the instant case from records it is seen that those people who have paid by way of donation that includes the cheque with a letter with a specific direction, which is in compliance with section 11(1)(d). But, in case the contributions are made without cheque, i.e., by cash, and oral direction has been issued to the trust to utilise the said fund for the purpose of treating the leprosy patients and if such amounts are credited to the account meant for it, even then the requirement of section 11(1)(d) is complied with.

v) The attitude of the IT authorities is surprising who are over-technical in denying the benefit to the deserving institutions which are rendering laudable services to the rural masses. By not granting tax exemption, which they deserve, the authorities have hampered the said social activities of the trust and they are made to waste their precious time, energy and money in fighting this litigation. Unfortunately, the persons who took a decision to file an appeal before this court are wasting the precious time of the trust which could have been used in the social service. Public money and the time of this court is also wasted. This attitude on the part of the Department cannot be countenanced. Therefore, it is appropriate to impose cost incurred by the assessee for fighting litigation so that the Department would be more careful in taking decision to file appeal in such frivolous cases by ignoring the policy of the Government, viz., National Litigation Policy, 2011.

vi) Hence, the appeal is dismissed with cost of Rs. 1,00,000/-, to be deposited by the Department within one month from today in favour of the rural project fund of the assessee trust.”

levitra

Nirav Shah

Business income or house property income: S/s. 22 and 28: A. Y. 2003-04: Assessee owner of property: Hotel run in property by company of which assessee was director: No lease of property: Share of profits received by assessee: Assessable as business income:

CIT vs. Francis Wacziarg; 353 ITR 187 (Del):

Assessee was the owner of the property. Hotels were run in the property by a company in which assessee was director. There was no lease agreement. The assessee was entitled to a certain share in the gross operating profit calculated in terms of the agreement. The asessee disclosed the income as business income and claimed deduction of expenditure and depreciation. The Assessing Officer assessed the income as income from house property and disallowed the claim for deduction of expenditure and depreciation. The CIT(A) and the Tribunal allowed the assessee’s claim.

On appeal by the Revenue, the Delhi High Court upheld the decision of the Tribunal and held as under:

“i) The Commissioner (Appeals) had given a detailed factual finding why income earned by the assessee from the three properties was taxable under the head “Income from business or profession” and not under the head “Income from house property”. This finding had been upheld by the Tribunal. The findings were not perverse and were based on documents and material placed on record. This income was assessable as business income.

ii) Once it was held that the income from the three properties was taxable under the head “Income from business or profession” depreciation had to be allowed under the provisions of section 32. Similarly, disallowance of 80% from the expenses deleted by the Commissioner (Appeals)/Tribunal had been explained and supported by cogent reasoning. The depreciation and the expenditure were deductible.”

levitra

Nirav Shah

Business expenditure: S/s. 2(24)(x), 36(1)(va) and 43B: A. Y. 2001-02: Employees’ contribution towards ESI: Deposited before due date for filing return though after due date prescribed under ESI Act, 1948: Deduction to be allowed: No distinction to be made between employer’s contribution and employees’ contribution: Amendment of section 43B by Finance Act, 2003 deleting second proviso is retrospective:

CIT vs. Nipso Polyfabriks Ltd; 258 CTR 216 (HP):

For the A. Y. 2001-02, the assessee’s claim for deduction of employees’ contribution to ESI was disallowed by the Assessing Officer on the ground that the same was deposited after the due date prescribed under the ESI Act though it was deposited before the due date for filing the return of income. The Tribunal allowed the assessee’s claim.

On appeal by the Revenue, the following question was raised:

“Whether the Tribunal was correct in holding that amounts received by the assessee from employees for crediting to their accounts in provident fund and ESI but not so credited on or before the due dates specified under the respective statutes, were allowable deductions u/s. 36(1) (va) of the IT Act?”

The Himachal Pradesh High Court upheld the decision of the Tribunal and held as under:

“i) By the Finance Act, 1987 section 2(24)(x) was inserted and the sums collected by the assessee from his employees as contribution to provident funds and ESI were to be treated as income. By the same Act, section 36(1)(va) was introduced. Resultantly, the contribution of the employees collected by the employer was treated as his income. At the same time, the same was allowed as deductible expense if deposited within a particular time. Section 43B was also amended in the year 1987 itself and the two provisos were inserted. As per the amendment, there was no differentiation between the employer’s or employees’ contributions. Both had to be deposited by the due date as defined in the Explanation below cl. (va) of s/s. (1) of section 36. By the Finance Act of 2003, which came into effect from 1st April, 2004, the second proviso to section 43B which specifically made reference to section 36(1)(va) was deleted. The amendment was curative in nature and hence would apply with retrospective effect from 1st April, 1988.

ii) The second proviso to section 43B(b) specifically referred to the due date u/s. 36(1)(va) and as such, it cannot be urged that the provisions of section 43B and section 36(1)(va) should not be read together. It is clear that the law was enacted to ensure that the payment of the contributions towards the provident funds, the ESI funds or other such welfare schemes must be made before furnishing the return of income u/s. 139(1).

iii) Though the amount was not deposited by the due date under the Welfare Acts, it was definitely deposited before furnishing the returns. That is no reason to deny him the benefit of section 43B, which starts with a non obstante clause and which clearly lays down that the assessee can take benefit of deduction of such contributions, if the same are paid before furnishing the return. There is no reason to make any distinction between the employees’ contribution or the employer’s contribution.”

levitra

Nirav Shah

Bad debts: Section 36(1)(vii): A. Y. 2007-08: Assessee taking all assets and liabilities of two web portals from its holding company as going concerns: Debt due to holding company: Assessee is entitled to write off: Bad debt allowable:

CIT vs. Times Business Solutions Ltd. 354 ITR 25 (del):

Consequent
upon a scheme of demerger, the assessee company had acquired all the
assets and liabilities of two web based portals that were hitherto being
operated by the assessee’s holding company. The portals were acquired
as going concerns. In the A. Y. 2007-08, the Assessing Officer rejected
the claim for deduction of bad debt of Rs. 3,63,31,432/- on the ground
that these debts related to the years 2003 to 2006 when the web portals
were run and operated by the holding company and that the assessee could
not have written off the bad debts as such contravened section
36(1)(vii). The CIT(A) and the Tribunal allowed the assessee’s claim.

On appeal by the Revenue, the Delhi High Court upheld the decision of the Tribunal and held as under:

“i)
When the original owner would have been entitled to write off the bad
debts, the successor who acquires the assets and liabilities from the
previous owner would also be entitled to treat the bad debts in the same
manner in which the original owner was entitled under law.

ii)
The assesee had acquired all the assets and liabilities of two web based
portals from its holding company. The assessee, for the A. Y. 2007-08,
had written off the bad debts acquired from the holding company.
Therefore, the asessee was entitled to write off the irrecoverable bad
debts related to the years 2003 to 2006 when the web portals were run by
the holding company.

iii) The appeal is dismissed.”

levitra

Nirav Shah

THE FINANCE ACT, 2013

1 Introduction

1.1 Shri P. Chidambaram, the Union Finance Minister, presented the last effective Budget of the present term of the UPA II Government for the year 2013-14 on 28th February, 2013. The Finance Bill, 2013, introduced by him with his budget, contained 125 clauses, out of which only 53 clauses relate to ‘Direct Taxes’ and 72 clauses relate to ‘Indirect Taxes’. This year, there was no serious debate in the Parliament on the Finance Bill. The Finance Minister introduced 11 new clauses, which were more or less of clarificatory nature on 30th April, 2013, and the Bill was passed by the Lok Sabha on the same day without any debate. Similarly, the Rajya Sabha passed the Finance Bill without any debate on 2nd May, 2013. The Bill has received the assent of the President on 10th May, 2013.

1.2 While concluding his Budget Speech, the Finance Minister has, in Para 188, made some predictions as under:

“Any economist will tell us what India can become. We are the tenth-largest economy in the World. We can become the eighth, or perhaps the seventh largest by 2017. By 2015, we could become a $5 trillion economy, and among the [top] five in the world. What we will become depends on us and on the choices that we make. Swami Vivekananda, whose 150th birth anniversary we celebrate this year, told the people: “All the strength and succour you want is within yourself. Therefore, make your own future.”

1.3 In Para 185 of the Budget Speech, it is stated that the effect of changes in Direct Tax Laws this year will bring additional revenue of Rs. 13,300 crore. So far as Indirect Taxes are concerned, the additional revenue will be Rs 4,700 crore.

1.4 In this Article, the amendments made in the Income-tax Act, the Wealth Tax Act and Securities Transaction Tax (STT) are discussed. A new tax viz. “Commodities Transaction Tax” (CTT) is now levied u/s. 105 to 124 of the Finance Act, 2013. This is on the same lines as the STT. The important features of this new tax are also discussed in this Article.

2 Rates of income tax, surcharge and education cess:
2.1 Surcharge on Super-Rich:

There are no changes in the tax slabs, rates of income tax, or rates of Education Cess. In Para 126 of the Budget Speech, the Finance Minister has stated that “Fiscal consolidation cannot be effected only by cutting expenditure. Wherever possible, revenues must also be augmented. When I need to raise resources, who can I go to except those who are relatively well placed in society? There are 42,800 persons — let me repeat, only 42,800 persons — who admitted to a taxable income exceeding Rs. 1 crore per year. I propose to impose a surcharge of 10 percent on persons whose taxable income exceeds Rs. 1 crore per year. This will apply to individuals, HUFs, firms and entities with similar tax status.” In Para 127, he has stated that in the cases of domestic companies, the existing surcharge is 5% if the taxable income exceeds Rs. 1 crore. This will now be 10% if the taxable income exceeds Rs. 10 crore. Similarly, in the case of a foreign company the existing surcharge of 2% will increase to 5% — if the income exceeds Rs. 10 crore. In Para 128, the Finance Minister has stated that the existing surcharge of 5% will increase to 10% in case of tax on dividend distribution. Further, in Para 129 of his speech, he has stated that this additional surcharge will be in force only for one year i.e. financial year 2013-14 (A.Y. 2014-15).

2.2 Rebate from Tax:

In order to give a small relief to Resident Individual Tax Payers, a new Section 87A is inserted in the Income-tax Act (IT Act) w.e.f. A.Y. 2014-15. Under this section, a resident individual whose total income does not exceed Rs. 5 lakh, will be entitled to receive a rebate of Rs. 2,000/- or the income tax payable (whichever is less) from the income tax payable by him. It may be noted that this rebate cannot be claimed by an HUF.

2.3 Rates of Income-tax and Surcharge:

(i) For Resident Individuals, HUF, AOP, BOI and Artificial Juridical Person, as stated above, there are no changes in the tax slabs, rates of Income tax or rates of Education Cess. The only change is about levy of 10% surcharge on tax if the income exceeds Rs. 1 crore. The rates of tax for A.Y. 2013-14 and A.Y. 2014-15 (Accounting years ending on 31-03-2013 and 31-03-2014) are the same as stated below):

Notes:

•    In A.Y. 2014-15 Surcharge @ 10% of the tax will be payable if income of the assessee exceeds Rs. 1 crore.
•    An Individual having gross total income below Rs 5 lakh will get rebate upto Rs. 2,000/- from tax in A.Y. 2014-15 u/s. 87A.
•    Education Cess of 3% (2%+1%) of the tax is payable for both the years.

(ii) The following table gives figures of tax payable by Resident Individual, HUF, AOP, BOI etc. in A.Y. 2013-14 and A.Y. 2014-15.

(a) Tax payable in A.Y. 2013-14 (Accounting year ending on 31-03-2013)

Note: The above tax is to be increased by 3% of tax for Education Cess.

(b) Tax payable in A.Y. 2014-15(Accounting year ending on 31-03-2014)

Notes:

•    In the first two items (Rs. 3 lakh and Rs. 5 lakh) in the case of an Individual having income below Rs. 5 lakh, the tax payable will be reduced by Rebate of Rs. 2,000/- u/s. 87A.
•    The last item (Rs. 125 lakh) includes surcharge of 10%.
•    The above tax is to be increased by 3% of tax for Education Cess.

(iii) Other Assessees (excluding companies)

The rates of taxes (including rate of Education Cess) for the other assesses (excluding companies) for A.Y. 2013-14 and A.Y. 2014-15 are the same. No surcharge on tax was payable by Co-operative Societies, Firms, LLP or Local Authority in A.Y. 2013-14. However, in A.Y. 2014-15, if the income of the above entities exceed Rs. 1 crore, Surcharge @ 10% of tax will be payable.

(iv) For Companies:

The rates of Income tax for Companies for A.Y. 2013-14 and A.Y. 2014-15 are the same. For domestic companies, surcharge of 5% of tax is payable in A.Y. 2013-14 if the total income exceeds Rs. 1 crore. In A.Y. 2014-15, the rate of surcharge will be 5% if the total income exceeds Rs. 1 crore but does not exceed Rs. 10 crore. If the total income exceeds Rs. 10 crore, the rate of surcharge will be 10% of the tax payable on the entire income.

In the case of a foreign company there is no change in the rates of income tax in A.Y. 2013- 14 and A.Y. 2014-15. As regards surcharge, the rate is 2% of the tax if the total income exceeds Rs. 1 crore in A.Y. 2013-14. In A.Y. 2014-15, the rate of surcharge will be 2% if the total income exceeds Rs. 1 crore but does not exceed Rs. 10 crore. If the total income exceed Rs 10 crore the rate of surcharge will be 5% of the tax payable on the entire income.

In both the above cases, Education Cess @ 3% of tax is payable in A.Y. 2013-14 and A.Y. 2014-15.

(v) Rate of Tax u/s. 115JB (MAT)

The rate of tax (i.e. 18.5%) will be payable on the book profits of a company computed u/s. 115JB (MAT) in A.Y. 2013-14 and A.Y. 2014-15. The surcharge will be payable on this tax as stated in (iv) above. Education Cess @ 3% of the tax plus applicable surcharge will be payable as at present.

(vi) Rate of Tax u/s. 115JC (AMT)

The rate of tax (i.e. 18.5%) will be payable on the adjusted total income of non-corporate assesses u/s. 115JC (AMT) in A.Y. 2013 -14 and A.Y. 2014-15. The surcharge and Education Cess will be payable on this tax as stated in (iii) above.

(vii) Dividend Distribution Tax:

Dividend Distribution Tax or Income Distribution Tax payable u/s. 115O, 115QA, 115R or 115TA shall be pay-able as provided in these section. The surcharge at 10% of tax will be payable in respect of the above tax for A.Y. 2014-15. The Education Cess @ 3% of the tax shall also be payable on the above tax. It may be noted that surcharge @ 10% of tax will be payable irrespective of the amount distributed under these sections.

(viii) Rate of Tax on Dividends from Specified Foreign Companies:

The concessional rate of 15% plus applicable surcharge and Education Cess which was applicable for A.Y. 2013-14 u/s. 115BBD has been extended for one more year i.e. for A.Y. 2014-15.

2.4 Education Cess:

As in the earlier years, Education Cess of 3% (including 1% Higher Education Cess) of the income tax and applicable surcharge is payable by all resident assessees and non-resident assessees. No Education Cess or surcharge is applicable on TDS and TCS from payments to all resident corporate and non-corporate assesses. However, if tax is deducted from

(a) payments to foreign companies, (b) payments to non-residents or (c) salary to residents or non-residents, Education Cess at 3% of the tax and applicable surcharge is to be deducted.

3. Tax deduction and collection at source (TDS and TCS)

3.1 In the case of a resident assessee or a domestic company, where tax is required to be deducted or collected at source, no surcharge or Education Cess of the applicable rate of tax is to be considered. However, in the case of a non -resident or a foreign company while deducting or collecting tax at source, under the provisions of the Income-tax Act during the period commencing from 01-04-2013, the applicable rate of tax is to be increased by the applicable rate of surcharge and Education Cess. As stated earlier, in the case of non-residents (other than foreign companies), if the total income exceeds Rs. 1 crore, the rate of surcharge is 10% of the tax. In the case of a foreign company, if the total income is more than Rs. 1 crore but less than Rs. 10 crore, the rate of surcharge is 2% of the tax. If the income is more than Rs. 10 crore, this rate is 5% of the tax on total income. In all cases, the rate of Education Cess is 3% of the tax (including applicable surcharge).

3.2 TDS on transfer of immovable property:

(i) Section 194-1A – This new section is inserted in the Income-tax Act w.e.f. 01-06-2013. It provides that any person (transferee) who purchases any immovable property (whether residential or commercial) for a consideration, shall now deduct tax at source at the rate of 1% of the amount paid to a resident seller (transferor) if the said consideration exceeds Rs. 50 lakh. For this purpose, the term “Immovable Property”, is defined to mean any land (other than Agricultural Land) or any building or part of a building. It may be noted that the section will apply in both cases i.e. when the purchaser is purchasing the property as a capital asset or as stock-in-trade.

(ii) This section will apply to all assessees, whether resident or non-resident, who purchase any immovable property in India from a resident. In other words, the obligation for deduction of tax is on every purchaser of immovable property, whether he is required to get his books of accounts audited u/s. 44AB or not. It will not be necessary for the purchaser to obtain Tax Deduction Account Number (TAN) u/s. 203A.

However, the purchaser will have to file TDS Return and deposit TDS amount with the Government as provided in Section 200. The seller of the property must provide his PAN to the purchaser. If this is not done, tax on the sale consideration will have to be deducted at 20% as provided in section 206AA. It may be noted that the option of obtaining certificate from the A.O. u/s. 197 prescribing NIL rate or lower rate of TDS is not available in the above case.

(iii) If the purchase of the immovable property is from a non-resident, the tax will be deductible by the purchaser at the applicable rate u/s. 195 as at present. This new section will not apply to such a purchase. Similarly, this new section will not apply to payment of compensation on acquisition of immovable property to which the provisions of TDS u/s. 194LA are applicable.

(iv) It may be noted that a similar provision for TDS was proposed to be introduced by the insertion of section 194LAA in the Income-tax Act by the Finance Bill, 2012. Under this provision, it was proposed that the purchaser of an immovable property for a consideration exceeding Rs. 50 lakh in the specified area and Rs. 20 lakh in other areas shall deduct tax at source @ 1% of the consideration. For this purpose, the consideration was to be considered as specified in the Sale Deed or stamp duty valuation u/s. 50C whichever was higher. The registering authority was directed not to register the document unless the evidence for payment of TDS amount was produced before him. There was a lot of protest against the introduction of such a provision last year. Therefore, this provision was dropped before passing the Finance Act, 2012. A similar provision is again introduced this year and in the absence of any serious debate the same has been now brought into force from 01-06-2013.

(v) This new provision is likely to raise some issues as under:

(a) The definition of immovable property only covers land (other than agricultural land) or building or part of the building. This will mean that any right in a building such as tenancy right, leasehold right etc. will not be subject to this TDS provision. [Refer: Atul G Puranik vs. ITO 132 ITD 499 (Mum)]

(b) If a person has booked a flat in a building under construction, either the flat is booked before 01-06-
2013 or after that date, and makes payment for the same, a question will arise whether he is required to deduct tax at source under this section. It is possible to take the view that by the agreement with the builder the purchaser gets a right to get the flat when constructed. Therefore, when the instalment payments are made to the builder there is no transfer of immovable property. [Refer: ITO vs. Yasin Moosa Godil 147 TTJ 94 (Ahd)] The transfer of flat will take place only when possession is given.

Therefore, the obligation to deduct tax will arise under this section only when the last instalment is paid against possession of the flat. However, TDS @ 1% will have to be deducted on the entire consideration for the flat at that time.

(c) Since there is no specific mention in this section that if the amount of stamp duty valuation u/s. 50C is more than the actual consideration, the stamp duty valuation will be considered as consideration for TDS purposes, it can be concluded that tax is to be deducted from the actual consideration payable as per the sale deed. As stated earlier, in the Finance Bill, 2012 the proposed section 194LAA specifically provided for considering stamp duty valuation if that was more than the consideration stated in the Sale Deed. There is no such provision in this new section 194-1A.

(d) Section 199 of the Income-tax Act provides that credit for TDS amount will be given against the income in respect of which such tax is deducted. In a transaction of sale of immovable property, the seller will be showing income from such sale under the head “Capital Gains” or “Income from Business or Profession”. It may so happen that an individual selling his immovable property may claim exemption u/s. 54 or 54F due to reinvestment in another property or u/s. 54EC by reinvestment in Bonds. In all such cases, credit for TDS under this new section will be available even if the income computed under the head “Capital Gains” is NIL.

(e) If the property is purchased by two or more persons as co-owners, the tax will be deductible by each co-owner in respect of his/her share of the consideration paid if the total consideration for the property exceeds Rs. 50 lakh. This section also applies in respect of purchase of property from a relative.

(f) It may be noted that there is no provision for disallowance of purchase price of the property u/s. 40(a)(ia) in the case of a purchaser who has purchased the property as stock-in-trade.

3.3 tds from interest income of FII or qfi:

Section 194LD: This is a new Section inserted in the Income-tax Act w.e.f. 01-06-2013. This Section provides that any person paying interest to a Foreign Institutional Investor (FII) or a Qualified Foreign Investor (QFI) in respect of the following investment shall deduct tax at source at the rate of 5% plus applicable surcharge and Education Cess.

(a) Interest on a Government Security

(b) Interest on a rupee denominated bond of an Indian Company, provided that the rate of interest does not exceed the rate notified by the Central Government.

It may be noted that consequential amendments have been made in Sections 115A, 115AD, 195 and 196D. However, no consequential amendment is made in Section 206AA and, therefore, in the case of any FII or QFI, if PAN is not furnished tax will be deductible @ 20% plus applicable surcharge and Education Cess.

3.4 Section 206AA: This section is amended w.e.f. 01-06-2013. By this amendment, it is now clarified that in respect of interest paid to a non-resident or a foreign company on long term infrastructure bonds issued by an Indian Company in foreign currency as provided in section 194LC, the provisions of section 206AA will not apply from 01-06 -2013. Therefore, if such foreigner lender does not furnish PAN, the tax will be deducted at 5% plus applicable surcharge and Education Cess u/s. 194LC and not at the rate of 20% as provided in section 206AA.

It is surprising that similar concession is not given u/s. 206AA to tax deductible u/s. 194LD as discussed in Para 3.3 above.

3.5 Section 206C – Tax collection at source (TCS)

This section was amended last year w.e.f. 01-07-2012 by inserting s/s. (1D) in section 206C providing for TCS @ 1% of the sale consideration for bullion purchased by a buyer if the consideration exceeded Rs. 2 lakh and was paid in cash by the buyer. It was provided that for this purpose, the term “Bullion” shall not include any coin or any other article weighing 10 grams or less. This provision is now amended by the Finance Act, 2013, and it is provided that w.e.f. 01-06-2013, the exemption given from TCS provision to a coin or other article of bullion weighing 10 grams or less shall not be available. Therefore, tax will have to be collected @ 1% if the buyer of bullion (including any coin or other article) pays amount exceeding Rs. 2 lakh in cash.

4. Exemptions and Deductions:

4.1 Agricultural Land Section 2(1A) and 2(14):

These two sections of the Income tax Act have been amended w.e.f. A.Y. 2014-15.

(i) Section 2(14) defines the term “Capital Asset”.
As per the provisions of the section before the amendment, agricultural land situated within the jurisdiction of a Municipality, Cantonment Board etc. having population of more than 10,000 was considered as a Capital Asset. Similarly, agricultural land situated within the distance (not exceeding 8 kms) from the local limits of a Municipality, Cantonment Board etc. as notified was also considered as Capital Asset.

(ii) Section 2(14) has now been amended to provide that the agricultural land situated in any area within the following distance, measured aerially, from the local limits of any Municipality, Cantonment etc. shall be considered as a Capital Asset.

(a)    Within 2 kms having population of more than 10,000 but less than 1 lakh;
(b)    Within 6 kms having population of more than 1 lac but less than 10 lakh;
(c)    Within 8 kms having population of more than 10    lakh.

In other words, agricultural land situated outside the above territory will not be considered as Capital Asset u/s. 2(14).

(iii) The population for the above purpose is defined to mean population according to the last preceding census of which the relevant figures have been published before the first day of the Financial Year. The distance for the above purpose is to be measured “aerially”. This provision appears to have been made to settle the controversy about the method of measurement. In the case of CIT vs. Satinder Pal Singh 188 Taxman 54 (P&H) it was held that the distance should be measured by approach road and not by a straight line distance on a horizontal plane.

(iv) Section 2(1A) has similarly been amended w.e.f. A.Y. 2014-15.

Income derived from any building and situated in the immediate vicinity of the agricultural land is presently exempt as agricultural income, subject to certain conditions u/s. 2(1A). By amendment of this section, it is now provided that income from such building falling within the area specified in (ii) above will not qualify for exemption as agricultural income.

4.2 Keyman Insurance Policy – Section 10(10D)

(i) Section 10(10D) grants exemption to any sum received under a life insurance policy, subject to certain conditions. Amount received on maturity of Keyman Insurance Policy is not exempt u/s. 10(10D). There was a controversy whether the Keyman Insurance Policy assigned to the beneficiary continues to be a Keyman Insurance Policy. Delhi High Court held in the case of CIT vs. Rajan Nanda 349 ITR 8 that the Keyman Insurance Policy becomes an ordinary policy on the life of the beneficiary on assignment and therefore the amount received under this policy will be exempt if other conditions of section 10(10D) are complied with. To overcome this decision, Explanation 1 to the section is now amended w.e.f. A.Y. 2014-15 to provide that the Keyman Insurance Policy which has been assigned to the beneficiary during its term, with or without consideration, will be considered to be a Keyman Insurance Policy u/s. 10(10D) and exemption under that section will not be available in respect of the amount received on maturity. It may be noted that for A.Y. 2013-14 and earlier years the exemption can be claimed on the basis of Delhi High Court decision in the case of CIT vs. Rajan Nanda 349 ITR 8.

(ii) One of the conditions for granting exemption provided in section 10(10D)(d) is that the annual premium payable in respect to a life insurance policy should not exceed 10% of capital sum insured. This percentage of the premium is increased to 15% in the case of insurance policy issued on or after 01-04-2013 on the life of (a) a person with disability stated in section 80U or (b) a person who is suffering from a disease or ailment specified u/s. 80DDB. Consequential amendment is made in section 80C also.

4.3 Securitisation Trusts: New Sections 10(23DA), 10(35A), 115TA to 115TC

(i) New Scheme for taxation of Income of Securitisation Trust (Trust) has been introduced from A.Y. 2014-15. For this purpose, new sections 10(23D), 10(35A), 115TA, 115TB and 115TC have been added. The terms “Securitisation Trust”, “Securities”, “Securitised Debt Instrument”, “Instruments” “Investor” and “Special Purpose Vehicle” are defined in section 115TC. These terms have the same meaning as given to them in SEBI (Public Offer and

Listing of Securitised Debt Instruments) Regulations, 2008 or the Guidelines on the securitisation of standard assets issued by RBI.

(ii) Under the new scheme the provisions can be summarised as under:

(a) Any income of the Trust from the activity of securitisation will be exempt from tax u/s. 10(23DA);

(b) Income received by the Investor holding any securitised debt instrument or securities issued by the Trust will be exempt in the hands of the Investor u/s. 10(35A);

• In the case of Individual or HUF – 25% Income tax plus applicable surcharge and Education Cess;

• In the case of others – 30% Income tax plus applicable surcharge and Education Cess;

• In the case of a person who is not liable to pay tax on such income – No tax is payable by the Trust.

The provisions for payment of the above tax on income distributed to Investors are contained in section 115TA to 115TC. These provisions are similar to tax payable on distribution of dividend by a company and tax payable on distribution of income by a Mutual Fund.

(iii) Section 115TA also provides for filing of Statement of income distributed and tax paid thereon, charging of interest for the delayed payment of tax and treating a person responsible for compliance with these provisions as an assessee in default for the non-compliance with provisions of sections 115TA to 115TC.

(iv) If one compares the existing provisions with the above new scheme, it will noticed that under the above scheme the total tax liability of the trust and Investors, put together, will be more.

4.4 Investor Protection Fund: New Section 10(23ED)

This is a new section inserted w.e.f. A.Y. 2014-15. This section grants exemption to any income, by way of contribution received from a Depository by an Investor Protection Fund (Fund) set up in accordance with the regulations notified by the Central Government. It may be noted that Depositories (NSDL or CDSL) are required to set up Investor Protection Fund as provided in SEBI (Depositories and Participants) Regulations, 1996. The above exemption is now provided to the Fund in respect of contribution by the Depository. It is also provides that if the Fund shares any amount with the Depository in any year, out of such exempt income, the amount so shared will be taxable in its hands. This section is on the same lines as section 10(23EA) which grants exemption to amount contributed by a recognised Stock Exchange to its approved Investor Protection Fund.

4.5 Venture Capital Fund: Section 10(23FB):

This section provides for exemption to any income of Venture Capital Company (VCC) and Venture Capital Fund (VCF) from investment in Venture Capital Undertaking (VCU). Essentially, this section treats VCC and VCF as pass-through entities. U/s. 10(23FB), the income of VCC and VCF is exempt but is taxable directly in the hands of investors in these entities u/s. 115U. The SEBI (VCF) Regulations, 1996, have been replaced by the SEBI (Alternative Investment Funds) Regulations, 2012 w.e.f. 12-05-2012. By amendment of Section 10(23FB), w.e.f. A.Y. 2013-14, the existing explanation has been substituted to provide as under:

(i) The pass-through status can be enjoyed by VCC and VCF that has been granted registration as category I Alternative Investment Fund;

(ii) VCC and VCF registered and governed by old VCF Regulations will continue to enjoy the pass through status;

(iii) VCC/VCF will have to comply with the conditions stated in the Explanation. Shares of the VCC and Units of the VCF should not be listed on any recognised stock exchange. 2/3rd of the investible funds should be invested in unlisted equity shares or equity linked instruments of a VCU. Further, the VCC should not invest any funds in a VCU in which its directors and substantial shareholders (10% or more holding) hold more than 15% of paid-up equity share capital of the VCU. Similar conditions are provided for VCF also.

4.6 Section 10(48):

Under this section, any income received in India in Indian currency by a foreign company on account of sale of crude oil to any person in India is exempt from tax, subject to certain conditions. The scope of this exemption is now expanded w.e.f. A.Y. 2014-15 and it is now provided that this exemption can be claimed by a foreign company in respect of income from sale to any person in India of crude oil, any other goods or rendering of services as may be notified by the Central Government.

4.7 New Section 10(49):

This new Section is inserted in the Income -tax Act to provide for exemption from tax to any income of the National Financial Holding Company Ltd., a company set up by the Central Government on 07-06-2012. This exemption is granted for A.Y. 2013-14 and for subsequent years.

4.8 Recognised Provident Fund:

One of the conditions in Schedule IV – Proviso to Rule 3 of Part A is that a Provident Fund will be considered as recognised under the Income tax Act only if the establishment for which the Provident Fund is set up is also exempted u/s. 17 of the P.F. Act. The date for obtaining such exemption under the P.F. Act which expired on 31-03-2013 under Rule 3 has now been extended by amendment of Rule 3 to 31-03-2014.

4.9 Rajiv Gandhi Equity Savings Scheme (RGESS): Section 80CCG:

At present, a resident individual, who is a first time retail investor, investing in listed equity shares under RGESS Scheme, is allowed a one time deduction of 50% of the eligible investment upto Rs. 50,000/- in the A.Y. 2013-14. Thus, the maximum deduction allowable under this section is Rs. 25,000/- if the gross total income of such individual does not exceed Rs. 10 lakh.

Now this section is amended w.e.f. A.Y. 2014-15 to provide as under:

(i) Limit of gross total income of the individual is increased from Rs. 10 lakh to Rs 12 lakh.

(ii) The scope of investment in eligible investment is extended to include listed units of an equity fund specified in RGESS. This includes investment in eligible shares, ETFs and Mutual Fund Units which has such eligible shares as the underlying assets.

(iii) The deduction upto Rs. 25,000/- (50% of investment upto Rs. 50,000/-) will now be available for each of the 3 consecutive assessment years beginning with the year in which such investment was first made.

(iv) There is a lock-in period of 3 years for such investment.

(v) If the prescribed conditions of RGESS are violated, the deduction originally granted will be deemed to be the income of the year in which such violation takes place.

4.10 Contribution to Health Scheme: Section 80D:

At present deduction u/s. 80D can be claimed in respect of premium on Mediclaim Policy upto Rs. 15,000/- (Rs. 20,000/- for Senior Citizens) by an individual or an HUF. Such deduction is also allowable for any contribution made to the Central Government Health Scheme or for preventive health check-up subject to the above limit. By amendment of this section the above benefit is now extended w.e.f. A.Y. 2014 -15 to contribution to such other Health Schemes as may be notified by the Central Government.

4.11 Additional Deduction for Interest on Housing Loans: Section 80EE:

This is a new section inserted in the Income tax Act w.e.f. A.Y. 2014-15. Under this section, one time deduction upto Rs. 1,00,000/- will be allowed to an individual for interest paid on Housing Loan taken for acquiring a residential house. This deduction will be over and above the deduction allowed for interest paid for the housing loan u/s. 24(b) of the Income-tax Act. This deduction can be claimed subject to following conditions.

(i) Housing Loan should be taken from a Bank, Financial Institution or a Housing Finance Company as defined in Section 80EE (5);

(ii) Housing Loan should have been sanctioned between 01-04-2013 to 31-03-2014;

(iii) Housing Loan sanctioned should not exceed Rs. 25 lakh;

(iv) The value of the residential house should not exceed Rs. 40 lakh;

(v) The individual claiming this deduction should not own any residential house on the date of sanction of the housing loan;

(vi) If the interest payable on the above loan, in A.Y. 2014-15, is less than Rs. 1,00,000/-, the assessee can claim deduction for the balance amount paid in A.Y. 2015-16. In other words, deduction allowable for interest on the housing loan in the A.Y. 2014-15 and 2015-16 cannot exceed Rs. 1,00,000/-.

It may be noted that this deduction cannot be claimed by an HUF. Further, there is no condition that the residential house should be self occupied. The assessee can let out the residential house. It also appears that if a residential house is purchased by two or more co-owners, each co-owner can claim the deduction for interest under this section against his share of income from the joint property.

4.12 Donation u/s. 80G:

This section is amended w.e.f. A.Y. 2014-15. At present, donation to National Children’s Fund is eligible for deduction u/s. 80G at the rate of 50% of the amount of the donation. This section is now amended to provide that 100% of the donation to National Children’s Fund made on or after 01-04-2013 will be eligible for deduction u/s. 80G.

4.13 Donation to Political Parties: Sections 80GGB and 80GGC.

These two sections provide for deduction from gross total income of 100% of the amount donated by any company, individual, HUF, firm, LLP or other specified persons to recognised Political Parties or Electoral Trusts. Now, it is provided, by amendment of these sections, that no such deduction will be allowed if such donation is made in cash on or after 01-04-2013. It may be noted that in sections 80G and 80GGA donation to approved trusts can be made in cash upto Rs. 10,000/-. So far as Political Donations are concerned, it is now provided that no cash donations will be eligible for deduction under the above sections.

4.14 Power Sector undertakings: Deduction u/s. 80IA.

This section provides for deduction of income of certain undertakings. This includes undertaking which commences its business of generation and/or distribution, transmission or distribution of power, or substantial renovation and modernisation of the existing transmission or distribution lines on or before 31-03-2013. By amendment of this section, the above time limit for commencement of business by such an undertaking is extended upto 31-03-2014.

4.15 Additional deduction for wages paid to New Workmen: Section 80JJAA:

Under the existing section, deduction is allowed to an Indian Company of an additional amount equal to 30% of the wages paid to new regular workmen employed by the Company in an industrial undertaking engaged in the manufacture or production of an article or thing, subject to certain conditions specified in this section.

This section is amended w.e.f. A.Y. 2014-15 to provide as under:

(i) Now the above deduction can be claimed by an Indian company only if it is deriving income from the manufacture of goods in a factory. For this purpose, the word “Factory” shall have the same meaning as in section 2(m) of the Factories Act, 1948;

(ii) The new regular workmen should be employed by the company in such factory;

(iii) This deduction can be claimed by the company in the year in which appointment is made and for two subsequent assessment years;

(iv) Such deduction is not allowable to the company in case the factory is hived off, transferred from another existing entity or acquired as a result of an amalgamation.

5. Income from Business or Profession:

5.1 Investment Allowance: New Section 32AC: This is a new section inserted in the Income tax Act w.e.f. A.Y. 2014- 15. The section provides for a one time deduction (Investment Allowance) to a company. This deduction can be claimed if the following conditions are complied with:

(i) This deduction can be claimed by a company engaged in the business of manufacture or production of any article or thing.

(ii) Such a company should acquire and install specified new asset between 1-4-2013 to 31-3-2015 for an aggregate cost exceeding Rs. 100 crore. If the specified new asset is acquired before 1-4-2013, this deduction cannot be claimed.

(iii) The above deduction is allowable at the rate of 15% of the actual cost of the specified new asset acquired and installed during the accounting year 2013-14 (A.Y. 2014-15) if the actual cost of such asset exceeds Rs. 100 crore. If such actual cost is less than Rs. 100 crore no deduction will be allowed in A.Y. 2014-15.

(iv)The company can claim deduction of 15% of the actual cost of such new asset acquired and installed during accounting year 2014-15 (A.Y. 2015-16) if the aggregate cost of the new asset during the period 1-4-2013 to 31-3-2015 exceeds Rs. 100 crore.

In other words, deduction of 15% can be claimed as under:

v) The deduction allowed under this section will be over and above the normal depreciation and additional depreciation (20%) allowable u/s. 32(1)(ii) and (iia) on the above specified new assets.

(vi) This being a special incentive for encouraging industrial companies which invest more than Rs. 100 crore in specified new assets, the amount of deduction allowed is not to be deducted from W.D.V. of the block of assets.

(vii) Further, this deduction is not for depreciation and, therefore, for the purpose of carry forward of losses, it will form part of business loss and not “unabsorbed depreciation”.

(viii) Since no provision for this deduction of 15% (investment allowance) is required to be made in the books of the company, deduction for this amount cannot be claimed for computation of Book Profits u/s. 115 JB.

(ix) For the purpose of this section, specified new asset means new plant and machinery. This will not include (a) ship or aircraft, (b) second hand plant and machinery (whether imported or not), (c) plant and machinery installed in office premises or residential premises (including guest house), (d) office appliances, (including computers or computer software), (e) vehicles, and (f) plant and machinery in respect of which 100% deduction by way of depreciation or otherwise is allowed in any previous year. It may be noted that intangible assets are not excluded from the definition of specified new asset. Therefore, any intangible asset attached to a plant and machinery can be considered as a specified new asset.

(x) It may be noted that this deduction will not be allowable to companies engaged in the business of hotel, hospital, road, bridge and other construction businesses.

(xi) There is a lock-in period of 5 years for the above specified new assets. If such asset is sold or transferred within 5 years of the date of installation, then the amount allowed as deduction in the earlier years will be taxable as profit or gain from business in the year of such sale or transfer. This will be in addition to the taxability of capital gains (if any) arising on such sale or transfer of such assets.

(xii) The above provision of lock-in period as stated in (xi) above, will not apply if the transfer of such asset is as a result of an amalgamation or a demerger. However, the Amalgamated Company or the Resulting Company will have to ensure that such new asset is not sold or transferred by it within 5 years from the date of installation by the Amalgamating Company or the Demerged Company.

5.2 Deduction of Bad/Doubtful Debts to Indian Banks: Section 36(1)(vii) and 36(1)(viia) – (i) Under the existing provisions of section 36(1)(viia), banks and financial institutions, depending upon their categories, are entitled to claim deduction for provision for bad and doubtful debts made for Urban and Rural Branches at specified rates. Similarly, a bank/financial institution is also entitled to claim deduction for bad debts actually written off u/s. 36(1)(vii) to the extent it is in excess of the credit balance in Provision for Bad and Doubtful Debts A/c made u/s. 36(1)(viia). Some doubts had arisen about the interpretation of the provisions of these two sections. In the case of Catholic Syrian Bank Ltd v/s CIT 343 ITR 270 the Supreme Court held that banks are entitled to full benefit of write off bad debts, written off u/s. 36(1)(vii) in addition to the deduction for the provision for bad and doubtful debts made u/s. 36(1)(viia). It is also held that, in the case of rural advances, there will be no double deduction for provision made u/s. 36(1)(viia). The proviso to section 36(1)(vii) limits its application to the bank which has made such provision u/s.6(1)(viia). The provision of section 36(1)(vii) and 36(1)(viia) and 36(2)(V) should be construed together. Thus, they form a complete scheme for deduction and prescribe the extent to which deduction is available to banks.

(II) For removal of doubts, section 36(1)(vii) has been amended from A.Y. 2014-15 by adding an Explanation that for the purpose of proviso to this section, the account referred to therein shall be only one account in respect of provision for doubtful debts u/s. 36(1)(viia). In other words, no distinction will be made for provision for urban and rural advances made u/s. 36(1)(viia). Therefore, in such cases, the amount of deduction in respect of bad debts u/s. 36(1)(vii) shall be limited to the amount by which the same exceeds the credit balance of the provision made u/s. 36(1)(viia).

5.3 Commodities Transaction Tax (CTT): Section 36(1) has been amended from A.Y. 2014-15 and it is now provided in section 36(1)(xvi) that the amount equal to CTT paid by the assessee in respect of the taxable commodities transactions entered by it in the course of its business will be allowed as its business expenditure.

5.4 Disallowance of certain payments by State Government Undertakings: Section 40(a)(iib) -This new clause has been added in section 40(a) from A.Y. 2014-15. Disputes had arisen in income tax assessments of some State Government Undertakings (SGU) as to whether any amount paid by SGU to the State Government by way of Royalty, Licence Fees, Service Fee, Privilege Fee, Service charges or any similar Fee/charge is deductible as business expenditure. It is now provided by this amendment that any such fee or charge which is levied exclusively on the SGU or is directly or indirectly appropriated from the SGU by the State Government will not be allowed as business expenditure to SGU. For this purpose, Explanation to the section defines SGU. (It includes a company in which the State Government has more than 50% of equity).

5.5 Commodity Derivative Transactions:
Section 43(5) – This section defines a “Speculative Transaction”. At present, it excludes from this definition certain transactions, including eligible transactions in respect of derivative transactions carried out in a recognised Stock Exchange. In view of introduction of MCX as a recognised association for commodities transactions, this section is now amended from A.Y. 2014-15 to provide that eligible transactions in Commodity Derivatives entered into through a recognised association will not be considered as speculative transactions.

5.6 Full value of consideration of Immovable Property held as Stock-in-Trade: New section 43CA

– (i) This new section is inserted from A.Y. 2014-15. Therefore, it will apply to real estate transactions entered into on or after 1st April, 2013. U/s. 50C, in the case of transfer of an immovable property (land, building or both) which is held by the seller as a capital asset, if the consideration is less than the market value adopted (assessed or assessable) for the purpose of payment of stamp duty, such stamp duty valuation is considered as the full value of the consideration u/s. 50C. Thus, the capital gain in the hands of the seller is computed on that basis as provided u/s. 50C. This provision was not applicable to immovable property held by the seller as stock-in-trade.

(ii) By introduction of this new section 43CA, it is now provided that the above concept of section 50C of adopting stamp duty valuation as full value of consideration will apply for computation of business income in the hands of seller who holds such property as stock-in-trade. The provisions of section 50C are made applicable w.e.f. 01-04-2013, to the extent applicable, to such transactions. This new provision will apply to Builders, Developers and Dealers engaged in real estate transactions. The provision will apply according to the method of accounting followed by the assessee. It may be noted that this new provision will not apply when the assessee makes a slump sale of the business as a going concern.

(iii) It is also provided in this Section that if there is a time gap between the date of the agreement of sale and the date of registration. The full value of the consideration will be determined with reference to the stamp duty valuation assessable on the date of the agreement of sale provided that full or part of the consideration stated in the agreement was paid, otherwise than in cash.

(iv) It may be noted that the definition of immovable property for the purpose of this section or section 50C does not include any right in the immovable property such as leasehold or tenancy right etc. If the assessee has booked a flat in a property under construction, the right to get possession of the flat is not covered under the section. However, when the property is constructed and the possession of the flat is taken, the section will apply with reference to the Agreement for sale when executed.

(v) It may be noted that section 56(2)(vii)(b) has been amended as discussed in Para 6 below. Effect of this amendment is that w.e.f. 01-04-2013, in the case of a purchaser of an immovable property, if the difference between the stamp duty valuation and the actual consideration paid as per the agreement of sale is more than Rs. 50,000/-, such difference will be considered as “income from other sources” in the hands of such purchaser. However, this provision will not apply if the purchase is from a relative as defined in Explanation to section 56(2)(vii). From this provision, it will be noticed the difference between the stamp duty valuation and actual consideration will be taxable in the hands of the seller as well as the purchaser if such difference exceeds Rs. 50,000/-.

6. Income from other sources: Section 56(2)(vii)(b) – (i) This section is amended from A.Y. 2014-15. This section provides for levy of tax on certain gifts received from non-relatives. This amendment comes into force in respect of transactions relating to purchase of immovable property i.e. land, building or both made on or after 01-04-2013. Prior to 31-03-2013, if an immovable property was received by an Individual or HUF from a non-relative, without consideration, the market value (based on the stamp duty valuation) on the date of the gift, if it exceeds Rs. 50,000/-, was treated as income from other sources in the hands of the assessee. There is no change in this provision. However, it is now provided, w.e.f. 01-04-2013, that if the purchase of an immovable property by an Individual or HUF is made for consideration which is less than the stamp duty valuation assessed or assessable by the stamp duty authorities, the difference will be taxable as income in the hands of the purchaser. This provision will apply only if such difference is more than Rs. 50,000/-.

(ii) It is now also provided by this amendment that if there is a time gap between the date of the agreement for purchase of the property and date of registration of the agreement, the stamp duty valuation assessable on the date of the agreement will be considered for this purpose. This concession will apply only if the full or part of the consideration stated in the agreement is paid by the purchaser by any mode other than cash before the date of registration.

(iii) For this purpose, the term “Immovable Property” is defined to mean “Land, Building or Both”. This will mean that any right in the immovable property will not be covered by this provision. Therefore, any tenancy right, leasehold right or similar right will not be considered as Immovable Property. If a flat in a building under construction is booked by the individual or HUF, the right to get possession of the flat will not be considered as purchase of immovable property under this section. Therefore, the consideration paid for this right as per the agreement will not be covered by this section.

(iv) If the stamp duty valuation is disputed, the provisions of section 50C for reference to Valuation
Officer will apply.

(v) It may be noted that if the difference between the stamp duty valuation and actual consideration exceeds Rs. 50,000/- tax will be payable on such notional amount by the seller as well as the purchaser under the following sections:

(a) In the case of the seller who is holding the immovable property as stock-in-trade as business income under new section 43CA – w.e.f. 01-04-2013.

(b) In the case of the seller who is holding the property as a capital asset, as capital gain u/s. 50C.

(c) In the case of Individual or HUF purchaser, under amended section 56(2)(vii)(b) – w.e.f. 01-04-2013 as income from other sources.

(vi) It may be noted that in the hands of the individual or HUF, if such property is held as “Capital Asset”, then such an assessee will be entitled to claim that the stamp duty valuation of the property adopted for taxation u/s. 56(2)(vii)(b) should be deemed to be the cost of acquisition of such property. To this extent there will be some deferred benefit to such individual or HUF. This benefit is provided u/s. 49(4). This benefit will not be available to a person who purchases an immovable property and treats it as stock-in-trade of his business.

(vii) It may be noted that amendment similar to what has been made, as stated above, in section 56(2)(vii)(b) was made in section 50(2)(vii)(b) by the Finance (no.2) Act, 2009, w.e.f. 01-10-2009. When it was pointed out to the Government that such a provision is unjust as both the seller and the purchaser of the immovable property will have to pay tax on this same notional addition, it was realised by the Government and in the Finance Act, 2010, this provision for levying tax on the purchaser was deleted with retrospective effect from 01-10-2009. This year the same amendment is made to tax the purchaser w.e.f. 01-04-2013, which has the effect of levying tax on the seller as well as the purchaser on the same notional addition. No reasons are given in the Explanatory Statement issued with the Finance Bill, 2013, for reintroducing this provision.

7. Buy-back of shares and Dividend Distribution Tax: Sections 10 (34A), 115-O, 115 QA to 115QC and 115R:

7.1 (i) At present, when a company buys back its shares from shareholders u/s. 77A of the Companies Act the shareholder is liable to pay tax u/s. 46A on the difference between the amount received from the company and the cost of acquisition of shares as provided u/s. 48 under the head “Capital Gains”. This provision will continue to apply in the case of shares which are listed if such buy back is not through a Recognised Stock Exchange.

(ii) A new section 115QA is inserted w.e.f. 01-06-2013 which provides as under.

(a) This section applies to buy back of shares which are not listed by a domestic company (whether public or private) u/s. 77A of the Companies Act on or after 01-06-2013.

(b) The consideration paid by the company to its shareholders for such buy-back of shares will now be liable to additional tax in the hands of the company at the rate of 20% plus 10% surcharge on tax (i.e. 2%) and 3% Education Cess on the tax (i.e. 0.66%) (Aggregate 22.66%). This tax is to be paid on the amount of such consideration after deduction of the amount received on the issue of such shares.

(c) The shareholder receiving this consideration on buy back of shares will not be liable to pay capital gains tax u/s. 46A as provided in the new section 10(34A) introduced w.e.f. A.Y. 2014-15.

(d) The above tax is to be deposited with the Government within 14 days of the payment of the consideration by the company to the shareholders.

(e) No credit for such tax can be claimed by the shareholder or the company against any tax liability.

(f) The above provision is on the same lines as Dividend Distribution Tax payable u/s. 115-0.

(iii) New section 115QB is also inserted to provide that interest at the rate of 1% p.m. for each month or part of the month shall be payable for the delay in payment of tax as required u/s. 115QA. Further, under new section 115QC provision is made for considering the company as assessee in default if it does not comply with the provisions of section 115QA. These provisions are similar to existing sections 115P and 115Q.

(iv) In section 115QA, it is stated that from the consideration paid by the company for buy-back of shares, the amount received on issue of shares should be deducted and the tax @ 20% is to be paid on this net amount. The question for consideration is as to how the amount received on issue of shares will be worked out in the following cases:

(a) When shares are issued at a Premium.

(b) When shares are issued as Bonus shares.

(d) When shares are issued to employees at concessional rate under ESOP scheme.

(e) When shares are issued at a discount or there is reduction in face value of shares to write off losses under a High Court Order.

(f) When shares are issued on amalgamation or on demerger.

In all the above cases, it will not be possible to determine the exact amount received on the issue of a particular share which the shareholder has offered for buy-back. This practical difficulty will have to be resolved by the tax authorities by a issuing a clarification.

(v) In the above scheme of taxation of the net consideration paid on buy-back of shares, it will be noticed that the tax is payable by the company. However, at present, the shareholder holding shares as a Capital Asset, is pays tax on such buy-back on the surplus, after the following deductions, under the head capital gains, at applicable rate.

(a) Actual cost of shares or Indexed cost (if long term asset) is deductible from the consideration.

(b) Set off of other capital loss or brought forward loss can be claimed against such capital gain.

(c) Benefit of deduction u/s. 54EC or 54F is available if the consideration is invested in Bonds or purchase of a residential house.

Taking into consideration the above, it will be noticed that incidence of tax under the new section 115QA will be higher as compared to the present provisions. In the case of a person holding such shares as stock-in-trade he will not get benefit of deduction of actual cost or set off of business losses or set off of carried forward losses.

7.2 Section 115-0: This section deals with Dividend Distribution Tax (DDT) payable by a Domestic company on dividend distributed by it. Section 115-0 (1A) has now been amended w.e.f. 01- 06-2013 to provide that no DDT will be payable on the amount relatable to dividend received from a foreign subsidiary company on which tax is paid by the domestic company at 15% u/s 115 BBD.

7.3 Section 115R: (i) This section deals with the payment of additional tax by a Mutual Fund (other than an equity oriented mutual fund) on the income distributed to the unit holders. This section is amended w.e.f. 01-06-2013. Hitherto such additional tax payable in respect of income distribution to Individual or HUF unit holders (excluding Money Market Fund or liquid fund) was 12.5%. Now from 1-6-2013 such tax will be payable by Mutual Fund at the rate of 25%. This will mean that the amount to be distributed to such unit holders will be reduced.

(ii) There is also an amendment in the section from 1-6-2013 to the effect that the rate of tax payable in the case of income distribution by an Infrastructure Debt Fund Scheme to a Non-Resident (including foreign company) unit holder shall be 5% only.

(iii) Surcharge at the rate of 10% of tax and Education Cess at the rate of 3% of tax will also be payable on the above tax.

8. Tax Residency Certificate for Non-Residents(TRC): Sections 90 and 90A

(i)These two sections empower the Central Government to enter into Agreements with any foreign country, Specified Territory or certain specified/Notified Associations in Specified Territories for avoidance of double taxation (DTAA). The Finance Act, 2012, had amended section 90 by insertion of sub- section (2A) w.e.f. 01-04-2013 to provide that the provisions of new sections 95 to 102 dealing with General Anti Avoidance Rule (GAAR) will be applicable even if the provisions of DTAA are more favourable to the assessee. In other words, where GAAR is invoked the assessee cannot seek protection of beneficial provision of DTAA. Similar amendment was also made in section 90A.

(ii) These two sections have now been amended to provide that section 90(2A) as well as 90A(2A) will now apply w.e.f. A.Y. 2016-17 because applicability of the provisions of sections 95 to 102 dealing with GAAR has now been postponed to A.Y. 2016-17.

(iii) (a) In section 90(4) as well as 90A(4), last year an amendment was made to provide that a Non Resident cannot claim benefit of DTAA unless Tax Residency Certificate in the form prescribed is obtained from the foreign country/specified territory with which India has entered into DTAA. In this certificate, such Foreign Country/Territory was required to certify the place of residence and such other particulars which the Indian Tax Department may require to decide where the benefit claimed under a particular DTAA is available to the Non Resident assessee.

(b) Some doubts were expressed about the effect of the amendment on the evidential value of TRC. Subsequently, the CBDT issued a press release clarifying the issue as under. “The Tax Residency Certificate produced by resident of contracting state will be accepted as evidence that he is a resident of that contracting state and the Income tax Authorities in India will not go behind the TRC and question his residential status.”

(c) To give effect to the above assurance section 90(4) as well as 90A(4) have been amended and the requirements about the Tax Residency Certificate containing the prescribed particulars about the assessee being resident of the contracting foreign country/specified territory has now been removed with retrospective effect i.e. A.Y. 2013-14. After removal of the above requirements s/s. (5) has been added in section 90 as well as 90A to provide that the Non-Resident which has obtained TRC from the foreign country/specified territory shall provide such other documents and information as may be prescribed. This amendment is made w.e.f. A.Y. 2013-14.

9. Taxation of Non-Residents: Sections 115A and 115AD

9.1 Section 115A: This section deals with tax on Dividends, Royalty and Technical Service Fees in the case of a Non-Resident. This section is amended w.e.f. A.Y. 2014-15 as under :

(i) It is now provided that the tax on interest referred to in section 194LD from Rupee Denominated Bonds of Indian Company as discussed in para 3.3 above will be payable @ 5% plus applicable surcharge and the Education Cess.

(ii) Under the existing section 115A(i)(b), the rate of tax on Royalty and Fees for Technical services is 10%. With effect from 1-4-2013 (A.Y. 2014-15) that rate is increased to 25% plus applicable surcharge and the Education Cess.

9.2 Section 115AD : This section deals with taxation of Foreign Institutional Investors. By an amendment of this section, w.e.f. A.Y. 2014-15, it is now provided that the tax on interest referred to in section 194LD from Rupee Denominated Bonds of an Indian company, as discussed in para 3.3 above, will be payable @ 5% plus applicable surcharge and the Education Cess.

10. General Anti-Avoidance Rule (GAAR)

10.1 This was a new concept introduced in the Income tax Act by the Finance Act, 2012. Very wide powers were given to the tax authorities by these provisions. In new Chapter X–A, sections 95 to 102 were inserted. In para 154 of the Budget Speech, while introducing the Finance Bill, 2012, the Finance Minister had stated that “I propose to introduce a General Anti-Avoidance Rule (GAAR) in order to counter aggressive tax avoidance schemes, while ensuring that it is used only in appropriate cases, enabling review by a GAAR panel.”

10.2 The reasons for introducing GAAR provisions in the Income tax Act were explained in the Explanatory Notes attached to the Finance Bill, 2012 as under:

“The question of substance over form has consistently arisen in the implementation of taxation laws. In the Indian context, judicial decisions have varied. While some courts in certain circumstances had held that legal form of transactions can be dispensed with and the real substance of the transaction can be considered while applying the taxation laws, others have held that the form is to be given sanctity. The existence of anti-avoidance principles are based on various judicial pronouncements. There are some specific anti-avoidance provisions but general anti-avoidance has been dealt only through judicial decisions in specific cases.

In an environment of moderate rate of tax, it is necessary that the correct tax base be subject to tax in the face of aggressive tax planning and use of opaque law tax jurisdictions for residence as well as for sourcing capital. Most countries have codified the “substance over form” doctrine in the form of General Anti Avoidance Rule (GAAR).

In the above background and keeping in view of the aggressive tax planning with the use of sophisticated structures, there is a need for statutory provisions so as to codify the doctrine of “substance over form” where the real intention of the parties and effect of transaction and purpose of an arrangement is taken into account for determining the tax consequences, irrespective of the legal structure that has been superimposed to camouflage the real intent and purpose. Internationally several countries have introduced, and are administering statutory General Anti Avoidance Provisions. It is, therefore, important that Indian taxation law also incorporates a statutory General Anti Avoidance Provisions to deal with aggressive tax planning. The basic criticism of statutory GAAR which is raised worldwide is that it provides a wide discretion and authority to the tax administration which at times is prone to be misused. This vital aspect, therefore, needs to be kept in mind while formulating any GAAR regime.”

10.3 There was large scale opposition to the introduction of this provision in the form suggested in the Finance Bill, 2012, and the DTC Bill, 2010, pending consideration of the Parliament. This opposition was voiced by various Trade and Industry bodies in India and abroad. The Finance Minister responded to the various suggestions made by members of the Parliament and various Trade and Industry bodies while replying to the debate in the Parliament on 7th May 2012, in the following words.

“Certain provisions relating to a General Anti-Avoidance Rules (GAAR) have also been proposed in the Finance Bill, 2012. After examining the recommendations of the Standing Committee on GAAR provisions in the DTC Bill, 2010, I propose to amend the GAAR provisions as follows:

(i) Remove the onus of proof entirely from the tax payer to the Revenue Department before any action can be initiated under GAAR.

(ii) Introduce an independent member in the GAAR approving panel to ensure objectivity and transparency. One member of the panel now would be an officer of the level of Joint Secretary or above from the Ministry of Law.

(iii) Provide that any tax payer (resident or non-resident) can approach the Authority for Advances Ruling (AAR) for a ruling as to whether an arrangement to be undertaken by the assessee is permissible or not under the GAAR provisions.

To provide greater clarity and certainty in the matters relating to GAAR, a Committee has been constituted under the Chairmanship of the Director General of Income Tax (International Taxation) to give recommendations for formulating the rules and guidelines for implementation of the GAAR provisions and to suggest safeguards so that these provisions are not applied indiscriminately. The Committee has already held several rounds of discussion with various stakeholders including the Foreign Institutional Investors. The Committee will submit its recommendations by 31st May, 2012.

To provide more time to both tax payers and the tax administration to address all related issues. I propose to defer the applicability of the GAAR provisions by one year. The GAAR provisions will now apply to Income of Financial Year 2013-14 and subsequent years.”

10.4 For the reasons stated above, special provisions relating to GAAR were made in sections 95 to 102 in the Income tax Act from A.Y. 2014-15 (Accounting Year ending 31-3- 2014) and onwards. These provisions applied to all assesses (Residents or Non-Residents) in respect of their transactions in India as well as abroad. Wide powers were given to the tax authorities to disregard any agreement, arrangement or any claim for expenditure, deduction or relief.

10.5 The GAAR provisions contained in sections 95 to 102 (chapter X-A) and in section 144-BA which were introduced by the Finance Act, 2012, w.e.f. A.Y. 2014-15 have now been withdrawn and replaced by another set of provisions in new chapter X-A (sections 95 to 102) and new section 144-BA by the Finance Act, 2013, w.e.f. A.Y. 2016-17 (Accounting year 01-04-2015 to 31-03-2016).

10.6 In para 150 of the Budget Speech while introducing the Finance Bill, 2013, the Finance Minister has stated as under:

“150. Hon’ble Members are aware that the Finance Act, 2012 introduced the General Anti Avoidance Rules, for short, GAAR. A number of representations were received against the new provisions. An expert committee was constituted to consult stakeholders and finalise the GAAR guidelines. After careful consideration of the report, Government announced certain decisions on 14-01-2013 which were widely welcomed. I propose to incorporate those decisions in the Income tax Act. The modified provisions preserve the basic thrust and purpose of GAAR. Impermissible tax avoidance arrangements will be subjected to tax after a determination is made through a well laid out procedure involving an assessing officer and an Approving Panel headed by the Judge. I propose to bring the modified provisions into effect from 01-04-2016.”

10.7 In the Explanatory Statement presented with the Finance Bill, 2013, the reasons for introducing the new provisions are explained as under:

“The General Anti Avoidance Rule (GAAR) was introduced in the Income tax Act by the Finance Act, 2012. The substantive provisions relating to GAAR are contained in Chapter X-A (consisting of section 95 to 102) of the Income tax Act. The procedural provisions relating to mechanism for invocation of GAAR and passing of the assessment order in consequence thereof are contained to section 144 BA. The provisions of Chapter X-A as well as section 144 BA would have come into force with effect from 1st April, 2014.

A number of representations were received against the provisions relating to GAAR. An Expert Committee was constituted by the Government with broad terms of reference including consultation with stakeholders and finalizing the GAAR guidelines and a road map for implementation. The Expert Committee’s recommendations included suggestions for legislative amendments, formulation of rules and prescribing guidelines for implementations of GAAR. The major recommendations of the Expert Committee have been accepted by the Government, with some modifications. Some of the recommendations accepted by the Government require amendment in the provisions of Chapter X-A and section 144 BA.”

GaarProvisions

10.8 In view of the above discussion, the existing sections 95 to 102 and 144BA have been now deleted. New set of Sections 95 to 102 and 144BA have been inserted in the Income tax Act w.e.f. F.Y.: 2015-16 (A.Y. 2016-17). These new provisions are discussed below broadly.

10.9 Section 95 : This section provides that an arrangement entered into by an assessee may be declared to be an impermissible avoidance arrangement. The tax arising from such declaration by the tax authorities, will be determined subject to provisions of sections 96 to 102. It is also stated in this section that the provisions of sections 96 to 102 may be applied to any step or a part of the arrangement as they are applicable to the entire arrangement.

10.10 Impermissible Avoidance Arrangement (Section 96) :

(i) Section 96 explains the meaning of Impermissible Avoidance Arrangement to mean an arrangement, the main purpose of which is to obtain a tax benefit and it –

(a) Creates rights or obligations which would not ordinarily be created between persons dealing at arm’s length.

(b) Results, directly or indirectly, in misuse or abuse of the provisions of the Income-tax Act.

(d) is entered into or carried out, by means, or in a manner, which are not ordinarily employed for bonafide purposes.

(ii) An arrangement whereby there is any tax benefit to the assessee shall be presumed to have been entered into or carried out for the main purpose of obtaining tax benefits, unless the assessee proved otherwise. It will be noticed that this was a very heavy burden cast on the assessee. The Finance Minister has, however, declared on 07-05-2012 that the onus of proof will be on the department who has to establish that the arrangement is to avoid tax before initiating the proceedings under these provisions.

10.11 Lack of Commercial Substance (Section 97) :

(i) Section 97 explains the concept of Lack of Commercial Substance in an arrangement entered into by the assessee. It states that an arrangement shall be deemed to lack commercial substance if:

(a) The substance or effect of the arrangement, as a whole, is inconsistent with, or differs significantly from, the form of its individual steps or a part of such steps; or

(b) It involves or includes:

–    Round Trip Financing
–    An accommodating party.
–    Elements that have the effect of offsetting Or cancelling each other; or
–    A transaction which is conducted through one or more persons and disguises the value, location, source, ownership or control of funds which is the subject matter of such transaction.

(ii) It involves the location of an asset or a transaction or the place of residence of any party which is without any substantial commercial purpose. In other words, the particular location is disclosed only to obtain tax benefit for a party, or

(iii) It does not have a significant effect upon the business risks or net cash flows of any party to the arrangement apart from any effect attributable to the tax benefit that would be obtained.

(iv) For the above purpose, it is provided that round trip financing includes any arrangement in which through a series of transactions –

(a) Funds are transferred among the parties to the arrangement, and,

(b) Such transactions do not have any substantial commercial purpose other than obtaining tax benefit.

(iii) It is further stated that the above view will be taken by the tax authorities without having regard to the following:

(a) Whether or not the funds involved in the round trip financing can be traced to any funds transferred to, or received by, any party in connection with the arrangement.

(b) The time or sequence in which the funds involved in the round trip financing are transferred or received, or

(c) The means by, manner in, or mode through which funds involved in the round trip financing are transferred or received.

(iv) The party to such an arrangement shall be treated as “Accommodating Party” whether or not such party is connected with the other parties to the arrangement, if the main purpose of, direct or indirect tax benefit under the Income tax Act.

(v) It is clarified in the section that the following factors may be relevant but shall not be sufficient for determining whether the arrangement lacks commercial substance.

(a) The period or the time for which the arrangement exists

(b)The fact of payment of taxes, directly or indirectly, under the arrangement.

(c) The fact that an exit route, including transfer of any activity, business or operations, is provided by the arrangement.

10.12 Consequence of Impermissible Avoidance Arrangement (Section 98) :

Under the newly inserted section 144BA, the Commissioner has been empowered to declare any arrangement as an impermissible avoidance arrangement. Section 98 states that if an arrangement is declared as impermissible, then the consequences, in relation to tax or the arrangement shall be determined in such manner as is deemed appropriate in the circumstances of the case. This will include denial of tax benefit or any benefit under applicable DTAA. The following is the illustrative list of consequences and it is provided that the same will not be limited to the list.

(i) Disregarding, combining or re-characterising any step in, or part or whole of the impermissible avoidance arrangement;

(ii) Treating, the impermissible avoidance arrangement as if it had not been entered into or carried out;

(iii) Disregarding any accommodating party or treating any accommodating party and any other party as one and the same person;

(iv) Deeming persons who are connected persons in relation to each other to be one and the same person;

(v) Re-allocating between the parties to the arrangement, (a) any accrual or receipt of a capital or revenue nature or (b) any expenditure, deduction, relief or rebate;

(vi) Treating (a) the place of residence of any party to the arrangement or (b) situs of an asset or of a transaction at a place other than the place or location of the transaction stated under the arrangement.

(vii) Considering or looking through any arrangement by disregarding any corporate structure.

(viii) It is also clarified that for the above purpose that tax authorities may re-characterise (a) any equity into debt or any debt into equity, (b) any accrual or receipt of Capital nature may be treated as of revenue nature or vice versa or (c) any expenditure, deduction, relief or rebate may be recharacterised.

10.13 Section 99 : This section provides for treatment of connected persons and accommodating party.

The section provides that for the purposes of sections 95 to 102, for determining whether a tax benefit exists –

(i) The parties who are connected persons, in relation to each other, may be treated as one and same person.

(ii) Any accommodating party may be disregarded.

(iii) Such accommodating party and any other party may be treated as one and same person.

(iv) The arrangement may be considered or looked through by disregarding any corporate structure.

10.14 It is further provided in section 100 that the provisions of sections 95 to 102 shall apply in addition to, or in lieu of, any other basis for determination of tax liability. Section 101 gives power to CBDT to prescribe the guidelines and lay down conditions for application of sections 95 to 102 relating to General Anti-Avoidance Rules (GAAR). Let us hope that these guidelines will specify the type of arrangements and transactions in relation to which alone the tax authorities have to invoke the provision of GAAR. Further, it is necessary to specify that if the tax benefit sought to be obtained by any arrangement is, say Rs. 5 crore or more in a year, then only the tax authorities will invoke these powers.

10.15 Section 102 : This section defines words or expressions used in sections 95 to 102 as stated above. Some of these definitions are as under:

(i) “Arrangement” means any step in, a part or whole of any transaction, operations, scheme, agreement or understanding, whether enforceable or not, and includes the alienation of any property in such transaction, operation, scheme, agreement or understanding.

(ii) “Connected Person”, in relation to a person who is an Individual, Company, HUF, Firm, LLP, AOP or BOI is defined in more or less the same manner as the term “Related Person” is defined in section 40A(2). It may be noted that, for this purpose, the definition of the word “Relative” is wider in as much as the definition of “Relative” given in Explanation to section 56(2)(vi) is adopted, whereas in section 40A(2) the narrower definition of “Relative” given in section 2(41) is adopted.

(iii) “Fund” includes (a) any cash, (b) cash equivalents and (c) any right or obligation to receive or pay in cash or cash equivalent.

(iv) “Party” means any person, including Permanent Establishment which participates or takes part in an arrangement.

(v) “Relative” has the same meaning as given in section 56(2)(vi) – Explanation. It may be noted that this definition is very wide as compared to the definition given in section 2 (41) which is adopted for the purpose of explaining related person in section 40 A (2).

(vi) The definition of a person having substantial interest in the company and other non-corporate bodies is the same as given in section 40A (2).

(vii) “Tax Benefit” includes (a) a reduction, avoidance or deferral of tax or other amount payable under the Income tax Act, (b) an increase in a refund of tax or other amount under the Act, (c) a reduction, avoidance or deferral of tax or other amount that would be payable under the Act, as a result of tax treaty, (d) an increase in a refund of tax or other amounts under the Act as a result of tax treaty, (e) a reduction in total income or (f) increase in loss in the relevant accounting year or any other accounting year.

(viii) “Tax Treaty” means Agreements entered into by the Government with any foreign country, territory or Association u/s. 90 or 90A.

10.16 Section 144 BA : Procedure for declaring an arrangement as impressible u/s. 95 to 102 is given in this section. This section will come into force from A.Y. 2016-17.

(i) The Assessing Officer can, at any stage of assessment or reassessment, make a reference to the Commissioner for invoking GAAR. On receipt of reference the Commissioner has to hear the tax payer. If he is not satisfied by the submissions of the taxpayer and is of the opinion that GAAR provisions are to be invoked, he has to refer the matter to an “Approving Panel”. In case the assessee does not object or reply, the Commissioner can issue such directions as he deems fit in respect of declaration as to whether the arrangement is an impermissible avoidance arrangement or not.

(ii) The Approving Panel has to dispose of the reference within a period of six months from the end of the month in which the reference was received from the Commissioner.

(iii) The Approving Panel can either declare an arrangement to be impermissible or declare it not to be so after examining material and getting further inquiry to be made. It can issue such directions as it thinks fit. It can also decide the year or years for which such an arrangement will considered as impermissible. It has to give hearing to the assessee before taking any decision in the matter.

(iv) The Assessing Officer (AO) can determine consequences of such a positive declaration of arrangement as impermissible avoidance arrangement.

(v) The final order, in case any consequences of GAAR are determined, shall be passed by the AO only after approval by Commissioner and, thereafter, first appeal against such order shall lie to the Appellate Tribunal.

(vi) The period taken by the proceedings before Commissioner and the Approving Panel shall be excluded from time limitation for completion of assessment.

(vii) The Central Government has to constitute one or more Approving Panels. Each Panel shall consist of 3 members, including a chairperson. The constitution of the Panel shall be as under.

(a) Chairperson – He shall be a sitting or retired judge of a High Court.

(b) Members – One member shall be IRS of the rank of CCIT or above.

– One member shall be an academic or scholar having special knowledge of matters such as direct taxes, business accounts and international trade practices.

The term of the Panel shall ordinarily be for one year and may be extended from time to time upto 3 years. The Panel shall have power similar to those vested in AAR u/s. 245U. CBDT has to provide office infrastructure, manpower and other facilities to the Approving Panel’s members. The remuneration payable to Panel members shall be decided by the Central Government.

(viii) In addition to the above, it is provided that the CBDT has to prescribe a scheme for efficient functioning of the Approving Panel and expeditious disposal of the references made to it.

(ix) Appeal against order of assessment passed under the GAAR provisions, after approval by the appropriate authority, is to be filed directly with the ITA Tribunal and not before CIT(A). Section 144C relating to reference before DRT does not apply to such assessment order and, therefore, no reference can be made to DRT when GAAR provisions are invoked.

10.17 The above GAAR provisions will have far reaching consequences for assessees engaged in the business with Indian or Foreign parties. GAAR is not restricted to only business transactions. Therefore, all assessees who are engaged in business or profession or who have no income from business or profession will be affected by these provisions. It appears that any assessee having any arrangement, agreement, or transaction with a connected person will have to take care that the same is at Arm’s Length Consideration. In particular, an assessee will have to consider the implications of GAAR while (a) executing a WILL or Trust, (b) entering into a partnership or forming an LLP, (c) taking controlling interest in a company, (f) entering into amalgamation of two or more companies, (c) effecting demerger of a company, (f) entering into a consortium or joint venture, (g) entering into foreign collaboration, or (h) acquiring an Indian or Foreign company. It may be noted that this is only an illustrative list and there may be other transactions which may attract GAAR provisions.

10.18 From the wording of the above provisions of sections 95 to 102 and 144BA it appears that the provisions of GAAR can be invoked even in respect of an arrangement made prior to 01-04-2015. The CIT or the Approving Panel can hold any such arrangement entered into prior to 01-04-2015 as impermissible and direct the AO to make adjustments in the computation of income or tax in the assessment year 2016-17 or any year thereafter. As stated in para 15.15 of the report of the Standing Committee on Finance on the DTC Bill, 2010 it would be fair to apply GAAR provisions prospectively so that it is not made applicable to existing arrangements/transactions. Even in the Press Note issued by the Central Government on 14-01-2013 it was stated that transactions entered into prior to 30-08-2010 will not made subject to GAAR provisions. This has not been provided in the above sections and, therefore, the above GAAR provisions will have a retrospective effect.

10.19 In section 101, it is stated that CBDT will issue guidelines to provide for the circumstances under which GAAR should be invoked. Let us hope that these guidelines will specify that GAAR provisions will apply to all arrangements or transactions entered into after 01-04-2015 and also the type of arrangements or transactions to which GAAR will apply. It is also necessary to specify that GAAR provisions will be invoked only if the tax sought to be avoided is more than Rs. 5 crore, in any one year. This is also suggested by the Standing Committee on Finance in their report on the DTC Bill, 2010. Even in the Press Note dated 14-01-2013, the Government had stated that there will be monetary threshold of Rs. 3 crore of tax benefit in a year for invocation of GAAR.

10.20 It may be noted that the above revised set of provisions for invoking of GAAR which will come into force on 01-04-2015 do not contain provisions relating to following decisions of the Government announced in the Government Press Note dated 14-1-2013.

(i) GAAR will not apply to an FII which does not avail treaty benefit.

(ii) GAAR will not apply to Non-Resident Investors in FII.

(iii) Where GAAR and SAAR are both in force, only one of them will apply subject to prescribed guidelines.

(iv) GAAR will be restricted to only “PART” of the arrangement which is impermissible and not to the whole arrangement.

Let us hope that these issues will be considered when CBDT issues the Guidelines for invocation of GAAR.

11. Assessments, Reassessments and Appeals:

11.1 Section 132B : This section, which deals with application of seized or requisioned assets, is amended w.e.f. 01 -06-2013. This section provides that the “existing liability” under the Income tax Act, Wealth tax Act, etc. and the amount of liability determined on completion of assessment under 153A and the assessment of the year relevant to the previous year in which search is initiated or requisition is made, or the amount of liability determined on completion of assessment for the block period (including any penalty levied or interest payable in connection with such assessment) may be recovered out of assets seized u/s. 132 or requisitioned u/s. 132A if such person is in default or is deemed to be in default. It was debatable as to whether the assets seized or requisitioned could be adjusted against advance tax payable. With effect from 01-06-2013, an Explanation 2 is inserted to this section to provide that the “existing liability” does not include advance tax payable in accordance with the provisions of the Income-tax Act.

11.2 Section 139(9) : This section explains when the return of income filed by the assessee u/s. 139 will be considered as defective. If these defects are not removed within the prescribed time, the A.O. will consider that the assessee has not filed the return. This section is now amended w.e.f. 01- 06- 2013. As per section 140A of the Act tax payable on the basis of return of income i.e. self assessment tax, along with interest payable, if any, is required to be paid by the assessee before furnishing the return of income. With effect from 1st June, 2013, non-payment of self assessment tax together with interest, if any, payable in accordance with the provisions of section 140A, before furnishing the return of income, shall make the return of income a defective return. This defect will have to be rectified on receipt of defect notice u/s. 139(9) within the prescribed time.

11.3 Section 142(2A) : This section empowers the CIT to order a Special Tax Audit of Accounts of the assessee in specified circumstances. At present, order for such audit can be passed having regard to the nature and complexity of the accounts of the assessee and taking into consideration the interest of the revenue. The scope of this section is now expanded w.e.f. 01-06-2013. By amendment of this section such order for Special Audit can be passed by the CIT having regard to –

(i) Volume of the accounts,

(ii) Doubts about the correctness of the accounts,

(iii) Multiplicity of transactions in the accounts and

(iv) Specialised nature of business activity of the assessee.

This new provision will cover a large number of assessees and although the accounts of large companies are audited by Statutory Auditors as well as Tax Auditors, they can be subjected to this Special Audit.

It may be noted that the CIT has to fix fees of the Chartered Accountant for such special audit on the basis of guidelines contained in Rule 14B and the same is payable by the Central Government.

11.4 Section 153 : This section deals with the time limit for the completion of Assessments and Reassessments. Some issues were arising in computation of this time limit. To resolve these issues the following amendments are made in this section with effect from different dates as stated below.

(i) If income of the assessee was first assessable in A.Y. 2009-10 or any subsequent year, and the matter is referred to the Transfer Pricing Officer (TPO) u/s. 92 CA, the time limit for completion of assessment will be 3 years from the end of the assessment year instead of 2 years. This amendment is effective from 01-07-2012.

(ii) In the case of reassessment where notice u/s. 148 is issued on or after 1-4-2010 and the case is referred to TPO u/s. 92CA, the time limit for completion of reassessment will be two years instead of 1 year. This is effective from 01-07-2012.

(iii) Where order of ITA Tribunal is received by CIT or where CIT has passed order u/s. 263 or 264 on or after 01-04-2010, and while passing the fresh assessment order, a reference is made to TPO u/s. 92CA, the time limit for completion of the fresh assessment will be two years instead of 1 year. This is effective from 01-07-2012.

(iv) Explanation 1(iii) to this section is amended from 01-06-2013. At present, in computing time limit for completion of assessment in a case in which AO has issued direction for special Audit u/s. 142(2A), the period from the date on which such direction is issued to the date on which the assessee is required to furnish report of the special Audit is to be excluded. It is now provided that, if the above direction is challenged in any court, the period upto the date on which such order is set aside by the court will also be excluded.

(v) Explanation 1(viii) to this section is amended w.e.f. 01-06-2013. It is now provided that while computing the time limit for completion of assessment the time taken for obtaining information from a foreign country/territory of foreign specified Association u/s. 90 or 90A will be excluded. This will be subject to a maximum of one year.

(vi) A new clause (ix) is added to Explanation 1 to the above section, effective from 01-04-2016. This relates to GAAR provisions as discussed in para 10 above. It is provided in this clause that the period from the date on which reference for declaration of an arrangement to be an impermissible avoidance arrangement is received by CIT u/s. 144BA and the date when direction from the CIT or the Approving Panel is received by the A.O. will be excluded for computing the period for completion of the assessment.

11.5 Section 153B : This section provides for time limit for completion of assessment in cases of Search and Seizure u/s. 153A. The section is amended from 01-07-2012, 01-04-2013 and from 01-04-2016 as stated in para 11.4 above. These amendments for computation of time limit for completion of the assessment or the reassessment are on the same lines as amendments in section 153 discussed in para 11.4 above.

11.6 Section 153D : This section provides for prior approval for assessment in cases of search or Requisition. This section is amended w.e.f. 01-04-2016. It is now provided that in cases of assessments or reassessments in respect of any of the years mentioned in section 153(1)(b) or the assessment year referred to in section 153B(1)(b), where the Assessing Officer has made a reference to the Commissioner to declare an arrangement as an impermissible avoidance arrangement and to determine the consequence of such an arrangement within the meaning of Chapter X- A, dealing with GAAR, the Assessing Officer shall pass the order of assessment or reassessment with the prior approval of the Commissioner. In such cases, the prior approval of the Joint Commissioner shall not be required.

11.7 Sections 167C and 179 : These sections deal with recovery of taxes due from partners of an LLP in liquidation and directors of a private limited company in liquidation respectively. These sections are amended w.e.f. 01-06-2013. Section 167C allows recovery from the partners of any tax due from an LLP in certain cases. Similarly, section 179 allows recovery from the directors of any tax due from a private company in certain cases. In certain decisions [e.g. Dinesh T. Tailor vs. TRO 326 ITR 85 (Bom.)] it has been held that the “Tax due” will not comprehend within its ambit a penalty or interest. Now, an Explanation is added to both these sections to provide that the expression “Tax due” shall include penalty, interest or any other sum payable under the Act. It would, therefore, be possible for tax authorities to recover not only the tax but also the penalty and the interest dues of an LLP or private company from its partners or directors respectively.

11.8 Sections 245N and 245R :(i) Section 245N(a) defines “Advance Ruling”. In view of the amendments relating to GAAR as discussed in para 10 above, section 245N(a)(iv) has been amended w.e.f. 01-04-2015 (A.Y.: 2016-17). It provides that a Non-Resident can obtain Advance Ruling under XIX-B in respect of determination or decision by Authority for Advance Ruling (AAR) whether an arrangement, which is proposed to be undertaken by a Resident or Non-Resident, is an impermissible avoidance arrangement as referred to in GAAR provisions. Consequential amendment is made in section 245N(b) also.

(ii) Section 245R is also amended effective 01-04-2015 to provide that AAR will not allow an application where it finds that the transaction is designed prime facie as arrangement which is impermissible avoidance arrangement.

11.9 Section 246A: This section provides for appeal to CIT(A). Clauses (1)(a)(b)(ba) and (c) of section 246A have been amended w.e.f. 01-04-2016 to provide that an assessment or reassessment order passed u/s. 143(3), 147 or 153A with the approval of CIT u/s. 144BA(12) or any order passed u/s. 154 or 155 in relation to such an order shall not be appealable before CIT(A). In all such cases, direct appeal before ITA Tribunal can be filed.

11.10 Section 252: This section deals with the constitution and appointment of the ITA Tribunal Members. This section is amended w.e.f. 01-06-2013. After this amendment, it is provided that the Central Government shall appoint a President of ITA Tribunal out of the following persons.

(i) A sitting or retired High Court Judge who has completed 7 years or more of service as such High
Court Judge.

(ii) Senior Vice President or one of the Vice Presidents of ITA Tribunal.

11.11 Section 253: This section provides for the list of orders against which appeal can be filed before the ITA Tribunal. Effective from A.Y. 2016 -17, it is now provided that such appeal can be filed directly before the ITA Tribunal against an assessment order passed u/s. 143(3) in regular case, in reassessment proceedings u/s. 147 or in search proceedings u/s. 153A with the approval of CIT u/s. 144BA. Even orders passed u/s. 154 or 155 to rectify mistakes in such proceedings u/s. 144BA will be subject to such appeals before ITA Tribunal u/s. 253.

11.12 Section 271FA: This section provides for levy of penalty for failure to furnish “Annual Information Return” (AIR). This section is amended effective from 01-04-2013 (A.Y. 2014-15). As per the existing provisions, in case of failure in furnishing AIR a penalty of Rs. 100 is leviable for each of day of default after the prescribed date. i.e. 31st August. If the Income tax authority issues notice requiring any person, who has failed to furnish an AIR to submit such return and such person does not furnish such return within the time provided in the notice then the enhanced penalty of Rs. 500 per day is now leviable for the period of such default after the expiry of time provided to furnish the return in the notice issued by AO.

12. Wealth tax act :

12.1 Section 2(ea): Explanation 1(b) defines “Urban land”. The existing definition is modified w.e.f. A.Y. 2014-15 in such a manner that Urban Land within the area as stated in the amended section 2(1A) of the Income tax Act (as discussed in para 4.1 above) will be included in the definition of Urban Land.

The Finance Minister has stated in his speech while replying to Budget discussion that no wealth tax will be levied on Agricultural Land as at present.

12.2 Sections 14A, 14B and 46 : These sections are amended w.e.f. 01-06-2013. So far provision for electronic filing of returns are applicable to returns filed under the Income tax Act.p Now, sections 14A, 14B & 46 of WT Act are inserted to facilitate electronic filing of annexure – less return of net wealth. Under these provisions, rules will be made for the following:

(i) The class of person who shall be required to furnish the return electronically.

(ii) The form and manner in which returns can be filed electronically.

(iii) The computer resource or the electronic record to which the return may be transmitted electronically.

(iv) The exemption from furnishing the documents, statements, reports, etc. along with the return filed in an electronic form.

13. Commodities transaction tax (ctt)

(i) The Finance Act, 2013 has introduced a new tax called Commodities Transaction Tax (CTT) to be levied on Taxable Commodities Transactions entered into in a recognised association. A transaction of sale of commodity derivatives in respect of commodities, other than agricultural commodities, traded in recognised associations is considered as Taxable Commodities Transaction.

(ii) CTT is leviable on sale of Commodities Derivatives at the rate of 0.01 per cent and the same is payable by the seller.

(iii) Section 36 of the Income-tax Act is amended to provide that CTT paid in the course of business shall be allowable as deduction if the income arising from such taxable commodities transactions is included in the income computed under the head “Profits and gains of business of profession”.

(iv) This tax is to be levied from the date on which Chapter VII of the Finance Act, 2013 relating to CTT comes in to force by way of notification by the Central Government.

(v) Sections 105 to 124 (Chapter VII) of the Finance Act, 2013, make detailed provisions for the levy of CTT, collection, filing of returns, assessments, appeals, rectifications, penalties etc. on the same lines as chapter VII of the Finance (No.2) Act, 2004 relating to STT.

14. Securities Transactions Tax (stt)

With effect from 1st June, 2013, the rates of STT have been revised as under:

15. General Observations:

15.1 This year’s budget being the last effective budget of the present Government can be considered as a soft budget. The provisions relating to GAAR which were to come into force from the current year have been postponed by two years. The provisions relating to the constitution of the Approving Panel and resolution of GAAR disputes have been strengthened. However, unless the mindset of the persons administering these provisions is changed, the tax payers will have to face hardships and they will face unending litigation. For implementing such complex provisions, the tax authorities have to implement these provisions by taking into consideration the ground realities of business and industry in our country. In implementing such provisions the tax authorities should not only consider the letter of the law but should consider the spirit behind this legislation. For this purpose, the CBDT will have to consider the business realities while framing the tax payer friendly guidelines for implementing these provisions.

15.2 As stated above, the Finance Minister has addressed the issue relating to GAAR to some extent. However, the provisions relating to taxation of Non-Residents introduced last year with retrospective effect have not been addressed. These provisions have affected our relationship with many foreign countries. This will affect our global trade in the long term. Disputes have arisen in some cases of large Multinationals and the Government is trying to resolve these disputes by enactment of separate legislation. When the Government has recognised that these disputes have arisen due to these retrospective amendments, it should have amended these provisions and given them only prospective effect.

15.3 One disturbing feature relates to the amendments made this year relating to TDS from consideration paid or payable on purchase of an Immovable Property under new section 194-IA. This will put tax payers and those who are not liable to pay tax into many practical difficulties of collecting 1% tax at source, depositing the same with the Government and filing return of TDS. There will be some issues relating to the date on which such tax is to be deducted when a flat is booked prior to 01-06-2013 or after that date in a building under construction and payments are made in instalments.

15.4 Amendment made in section 56(2)(vii)(b) levying tax on the notional amount of difference between stamp duty valuation of an immovable property sold and the actual consideration paid by an Individual or HUF (Purchaser). This will mean levying tax on the same notional amount in the hands of the seller as well as purchaser. It may be noted that such tax is not payable if the purchaser is a firm, LLP, company or persons other than individual or HUF. Similar tax was levied in 2009 but was withdrawn in 2010 with retrospective effect. It is unfortunate that the Government has again levied this type of tax which is payable by individual/HUF purchaser and seller of the property on the same notional amount. This is a very harsh and unjust provision in the Income-tax Act.

15.5 Provision made last year, effective from 01-04-2012 relating to “Specified Domestic Transactions” has increased the compliance cost of assessees. Transfer Pricing provisions have been made applicable to some domestic transactions. Although one year has passed since these provisions have come into force, there is no clarity about the type of transactions to which these provision will apply. No adequate data about comparable prices is available. In particular, there is no clarity as to how the assessing officers will compare the managerial remuneration paid to connected persons while making disallowance u/s. 40A(2). CBDT has not framed any separate Rule prescribing the information or documents required to be maintained by the assessee to whom this provision is applicable. No separate Form of Audit Report to be obtained u/s. 92E by the assessee to whom these provisions apply has been prescribed. We are informed that the provisions of Rule 10D and 10E and Form 3CEB of Audit Report prescribed for International Transactions can be used. If we refer to these Rules and the Form it will be noticed that there is no mention about Specified Domestic Transactions in these Rules or Form. It is not clear as to how specific requirements of these Domestic Transactions are to be reported in the Audit Report.

15.6 It may be noted that the present Finance Minister mooted the idea of replacing the present Income-tax Act and the Wealth Tax Act by Direct Taxes Code (DTC) in 2006-07. The DTC Bill, 2009 was circulated on 12.08.2009 for public debate. After considering the suggestions from various quarters, the DTC Bill, 2010, was introduced in the Lok Sabha and was to come into force w.e.f. 01.04.2012. The Bill was referred to the Standing Committee of the Finance. Since its report was delayed, DTC could not be passed in 2011 and hence its implementation was delayed. In Para 154 of the Budget Speech the Finance Minister has stated that DTC is work-in-progress. He has also stated that the report of the Standing Committee is received. The same is being examined and the revised Bill will be introduced in the budget session of the Parliament. This has not happened and it appears that this important legislation may not be passed during the present term of the UPA II Government.

15.7 Another legislation viz. Goods and Service Tax (GST) in the field of Indirect Taxes, was announced by the Finance Minister in 2007-08. He has referred to this in Para 186 of the Budget Speech this year. Due to differences in the views of various States, the required legislation has not been introduced in the Parliament. The Prime Minister has admitted that GST, which is to replace Excise Duty, Customs Duty, Service Tax and VAT laws in our Country may be enacted in 2014 after the elections by the new Government which may come to power.

15.8 Another major reform measure in the field of Corporate legislation relates to replacement of the Companies Act, 1956 by the Companies Bill, 2011. This Bill has been passed by the Lok Sabha in December, 2012. It is pending in the Rajya Sabha. The impression given to us was that this Bill will be passed in this year’s Budget Session and will come into force soon. This Bill is pending before the Rajya Sabha and this important legislation is also delayed.

15.9 The above three legislations are being discussed for the last more than five years but our Parliament is not able to legislate the same. We are assured that these new legislations will simplify our tax and Corporate Legislation and make the life of all stakeholders hassle free. Let us hope the Parliament in its wisdom legislates these provisions before the end of the current Financial Year.

(Acknowledgement: S.M. Jhaveri, Chartered Accountant and Dalpat H Shah, Chartered Accountant have assisted the Author in the preparation of this Article)

Nirav Shah

MEDIA AND ACCOUNTABILITY

The phone hacking scandal in the UK two years ago focused the world’s attention on media misconduct like rarely before. What was particularly shocking was that tabloid reporters hacked into and deleted the voice mail messages left by a missing 13-year-old girl, who was later found dead.

It triggered public outrage — understandably so — and led to the shutting down of Britain’s biggest Sunday paper, the arrests of the Prime Minister’s spokesman and several journalists and senior newspaper executives, the resignation of the country’s highest-ranking police officer, and the setting up of a public inquiry under Lord Justice Leveson.

A debate has raged since about whether the media should be subjected to greater regulation – not just in the UK, but in democracies around the world. Sections of the political class have, not surprisingly, supported the idea of stricter oversight and punishment.

There is often a thin line between regulation and control. In India, there have been periodic efforts at muzzling the media, most infamously during the Emergency. It is as much the public’s responsibility as it is the media’s to ensure that every such attempt is vigorously resisted. The media is meant to act as a watchdog; it has a duty to tell people things their governments don’t want them to know (barring genuinely sensitive information). This perforce casts it in an adversarial role.

The idea of democracy is predicated on freedom of the press (‘media’ and ‘press’ are used interchangeably here, and include print, broadcast and online). As the First Amendment of the US Constitution said, “Congress shall make no law…abridging the freedom of speech, or of the press; or the right of the people peaceably to assemble…” And while our own Constitution does not specifically refer to freedom of the press, it is implied in Article 19, which lists freedom of speech and expression as one of our fundamental rights. Various courts have over the years emphasised the centrality of freedom of the press to the democratic process.

Does that mean the media should not be held accountable for what it writes or broadcasts? Absolutely not.

Every industry and profession has a responsibility to its customers and clients. Just as an automobile manufacturer needs to answer for faulty brakes or a pharmaceutical company for substandard drugs or a CA firm for the quality of its audits, a newspaper or a TV channel must answer for inaccurate and irresponsible reporting.

Unlike say, a builder or a doctor, a journalist cannot directly cause a person’s death. But his incompetence or dishonesty can cause damage that some, especially the more righteous, might consider a fate worse than death – loss of reputation.

Yes, there are laws against defamation, slander and libel. While article 19(1)(a) guarantees free speech and expression, 19(2) specifies the grounds for “reasonable restrictions” on free speech (defamation, public order, incitement to an offence, etc).

But in practice, the media is protected, more by default than design, by the glacial speed at which things move through our judiciary. Most journalists know it takes years for a defamation case (like most other cases) to reach legal closure — unless the aggrieved party has the resources to hasten the process. By then the damage has been done. Punitive action, either in the form of compensation or an apology, a decade later is cold consolation for a person whose standing in society has been dented (although increasingly, it would appear that people don’t care).

There is also the Press Council of India, set up as a statutory body under a 1978 Act, to ensure freedom of the press and to hear complaints against newspapers. While Wikipedia describes it as an “extremely powerful body”, truth is, very few newspapers quake at the thought of being censured by the council.

A parliamentary standing committee recently submitted a report recommending either a single regulatory body for print and electronic media or a diarchy in which the Press Council has enhanced powers and there is a similar statutory body for the electronic media.

Such proposals have obviously not found great favour with the media, whose contention has always been: We don’t need outsiders to regulate us, we can do it ourselves.

There is reason to oppose external controls. What is the guarantee that the hidden hand of government will not seek to strangle a newspaper or channel that it considers inimical to its interests? Governments have been known to exert influence over institutions that are supposed to be completely independent. As it is, governments across the country routinely try to browbeat newspapers that run unfavourable stories by cutting off advertising — which amounts to abuse of power because it is taxpayers money they are using as leverage to block the people’s right to information. Many small and financially fragile papers, which depend on such advertising for survival, are often forced to fall in line.

Much of the credit for exposing corruption in high places must go to the media. It has acted, at least in some small way, as a check on governments, public officials and corporations from subverting the system.

But while the media is often quick to demand accountability from the executive and the legislature, who does it answer to? The obvious answer is: To the public in general and to its readers/viewers in particular.

As we all know, practice doesn’t always measure up to principle. Ministers and legislators can also seek refuge behind a similar defence by claiming, “We are elected by the people, and we answer to them. If they don’t like us, if they think we have lost the right to hold office, they can always vote us out.” But take a look at the scandals around us: Does it look like our politicians shiver with fear at the thought of their less-than-ethical practices inviting electoral backlash?

TV channels and newspapers like to claim that their viewers/readers have the freedom to switch out/unsubscribe, which would be bad for subscription and advertising revenue. So, if for nothing else, they’ll stay honest because it makes business sense.

There is some merit in this line of argument, but only up to a point. Corruption, whether at an individual or an institutional level, does not follow the laws of ethical business as they are taught in B-schools. When a journalist writes with mala fide intent, he is obviously not concerned about damaging reputations — of others, or his own.

One would like to believe that such dishonesty exists only on the fringes of established mainstream media, and that an overwhelming majority of us cannot be influenced to write in lieu of monetary or other favours. (We are leaving aside intellectual dishonesty, which is a separate subject by itself. Also, sponsored features or ‘advertorials’ do not fall under this category.)

So why do newspapers and TV channels still make so many mistakes, including some that can hurt people and their reputations? Much of it has to do with subject ignorance, lack of application (which is a polite way of saying ‘laziness’), inadequate fact-checking, and the rush to be first at any cost. A few unintentional, genuine mistakes are perhaps inevitable, even pardonable, given the tight deadlines newspapers and channels have to race against day in and night out — so long as those mistakes don’t end up hurting innocent people. And so long as we in media are prompt in acknowledging our mistakes.

The media’s challenge is to strike a delicate balance between being aggressive, sceptical and independent on one hand, and sensitive, decent and knowledgeable on the other. Combining so many attributes might seem like a tall order, but we need to hold ourselves to a higher standard. The paper I work for has taken a decision to play down news of school students committing suicide during exams and results. We are aware that other papers might choose to splash such ‘stories’ on front page, and we might look like we have missed them, but so be it. We believe it’s the right thing to do.

At the end of the day, we in the media need to do the right thing. This might sound simplistic, to the point of naivete. How can anyone expect a growing, fragmented, competitive industry that lies at the intersection of politics, business and a society in churn to develop the collective conscience to do the ‘right thing’? Surely, we’re expecting too much? Perhaps. But if an overwhelming majority of the media can learn to be fair and responsible, the law as it exists today is good enough to deal with a few rogue elements. Every industry has its seamy underbelly, but that cannot be a reason for any government to bring an AK-47 to a wrestling match.

If however the public comes to believe the media is incapable of managing its own house, we could be opening ourselves up to calls for tougher legislation and regulation. Recent developments in cricket should serve as a cautionary tale for all of us.

Nirav Shah

ACCOUNTABILITY OF THE ACCOUNTING PROFESSION

Introduction Every profession has an objective and purpose for its origin and sustenance. Accounting profession is no exception. While the role and significance of the accounting profession keeps evolving to match with the changing expectations of the stakeholders, laws and regulations, the underlying philosophy remains constant. The commitment of the profession to the society is enshrined in the motto adopted by The Institute of Chartered Accountants of India (ICAI) from the Kathopanishad – “Ya esa suptesu jagarti” – “That person who is awake in those that sleep”. The accounting profession is the conscience keeper of the finance world as its members perform the accounting and auditing and assurance services. The profession is recognised as a partner in nation building as its members provide value added services to business enterprises in terms of planning, budgeting, funding, restructuring, strategising growth and expansion, cost optimisation so on and so forth.

Evolution

Even before India became a Republic in 1950, the Gov-ernment of India enacted “The Chartered Accountants Act, 1949” and conferred the statutory and special recognition on the profession by chartering it and conferring autonomy on ICAI. This demonstrates the importance attributed to our profession by the Parliament and the need to regulate it with sound principles and standards. Since then, the profession has grown from strength to strength evolving its journey into a glorious history. The various milestones accomplished by its members reflect the astute wisdom acquired out of a sound learning process and robust practical training besides the recognition of our role given by the society. At the same time, we must acknowledge that autonomy comes with accountability and recognition is tagged on with responsibility. Assuming there are two professionals- one a member of our profession and another a non-member, with similar skills sets and knowledge, a client would prefer a member of our profession as there is a regulatory mechanism governing the profession and accountability in the case of a Chartered Accountant is better ensured than such a non-member. Accountability, therefore, is not a dis-advantage but an inherent strength of the profession.

In terms of membership strength, there has been phenomenal growth in the last one decade and consider-able number of members has been taking up employment in preference to public practice on account of enlarging opportunities in the industry. The following data demonstrates the shift in strength from public practice (COP) to employment (No COP) which also drives home the point that the profession is gaining more recognition in the in-house decision making and administration positions within the business segment. Instead of merely providing inputs for decision making, many of our members have attained positions whereby they are the decision makers for the business enterprise at the helm of affairs. There are many members who are CEOs and CFOs rendering yeomen service to the Industry segment of the Economy. The data also indicates that about 50% of them have entered the profession in the last one decade and therefore they all must be below the age of 35 years.

Scaling up with Quality

Out of the 1.2 billion population in India, only 2.17 lakh are qualified members of the profession. About a million students are pursuing the curriculum of our profession in various stages. Considering the fact that 47.5% of the 1.2 billion are youth below the age of 25 years, India has the demographic advantage of possessing substantial size of young population. Our profession can embrace good number of this segment in order to enable them to emerge as Chartered Accountants. This proposition may be fraught with two apprehensions namely, increase in number might lead to degeneration in standards and emergence of more professionals might lead to unemployment. Both these concerns do merit attention but can be effectively addressed by taking appropriate measures. We must ensure that quantity does not result in compromising of quality. The content of the curriculum, the examination and evalu-ation methodology and above all practical training and orientation should be constantly reviewed, monitored and implemented to match with the best expectations of the market. Further, the blending of technological skills with professional skills should be seamlessly and progressively done to equip the members to plunge into newer areas of services.

India has immense potential to emerge as a strong economic power being the third fastest growing economy next only to China and Indonesia. Although the present scenario is worrisome with GDP touching 4.8% growth in the fourth quarter of the last fiscal, our economy will bounce back soon to catch up with the desired 8% growth by 2015-16. Consequently, we should not have any inhibition to scale up with quality as otherwise persons with less competence and no accountability will strive to occupy the positions that would get generated with the growth of the economy. Further, our profession can contribute in a modest manner to the endeavour of reaping the demographic dividend by producing capable young finance professionals. India has the potential of emerging as the human resource hub for the rest of the world. There are already over 30,000 CAs settled abroad serving different economies. We must continue to produce professionals who are nurtured in India, but groomed for the world.

Knowledge Management and Innovation

The profession today stands on the threshold of dynamism and change. We need to be diligent in knowledge management and innovation. Any laxity on our part could be fatal. The government, the regulators, the society and the clients do expect the profession to take proactive measures for knowledge updating and skill upgradation. Both in the core areas of our practice such as assurance function as well as in the non-core areas such as consultancy/advisory functions, we need to be empowered consistently. Any inaction can create a void which will be filled by those outside our profession. John F Kennedy said that there are risks and costs to action but they are far less than the long range risks of comfortable inaction. We just cannot afford to be indifferent or ignorant of the developments around us. Practising the accountancy profession is like riding a bicycle and one does not fall off unless one stops pedalling. Learning is akin to pedalling. No other factor can inspire more confidence and faith of the stakeholders in our profession than the demonstrative quest for knowledge and competence gained out of it. The profession owes to the stakeholders an assur-ance that its members are the most competent and empowered lot to deliver services with quality. The profession can ill afford to be negligent on this aspect of the accountability.

Quality in service leads to excellence, which is a definite attribute that paves way for growth and development of the profession. However, there are limits to the excellence we can achieve on a narrow base. The profession needs to innovate and re-engineer itself to a new trajectory of divergence and efficiency. The profession needs to evolve new products, new services, new systems procedures and methodologies to maximise utility but minimise the cost. Excellence is like the summit of a pyramid, larger the base higher the summit. We should not spare any endeavour to broaden the base of the quality of our services with skills, standards and values and build the pyramid of excellence, the summit of which is unmatched by that of any other profession.

Capacity Building of Firms

It is common knowledge that Indian entrepreneurs are consolidating their businesses to grow big and face global competition. Multinationals are establishing subsidiaries of large size in India. Takeovers, mergers, amalgamations and collaborations are the order of the day. Professionals should also become conscious of this factor and gear up to restructure their firms, reorient their skills and expand their firm size. When an enterprise or a business group grows and the professional firm rendering service to it does not, the chances of replacement by a bigger firm cannot be ruled out.

On a closer look at the following data relating to the composition of the firms in our profession, it is not difficult to realise that most of them are small and medium practitioners (SMPs). Although there is commendable improvement in the growth and expansion of the firms over the last one decade, still we have a long way to go. To the growing Indian business enterprises, our profession is accountable to assure that our firms would measure up to the size that is required to ably cater to the array of services expected by them.

Independence and sanctity of signature

Unlike a few other professions where the accountability is primarily to the client, in our profession the account-ability extends to various stakeholders. For instance, when a member of the profession is exercising the assurance function in the nature of statutory audit and appends his signature, he is not only accountable to the shareholders who are the owners of the company but also to the investors, depositors, lenders – banks and institutions, regulators, customers and all those who make decisions relying on the authenticity of the financial statements so attested. Expression of independent and qualitative opinion is imperative for securing and fulfilling the accountability aspect of the profession. Attest function is the exclusive domain of our profession. We have been given this recognition on the faith that we will discharge it with utmost care and competence. Considering the fact that audit is not a privilege but a responsibility, it requires to be shouldered carefully by skilled and credible hands. Besides, audit is a time-bound exercise and, therefore, adequate trained manpower, infrastructure and audit tools and manuals are inevitable for a firm to acquit it creditably in discharging such function. Assurance function demands excellence, integrity and independence and when properly discharged commands unshakable faith, respect and image.

If warranted, based on facts and figures, we should have the mettle to express an adverse opinion on the financial statements of the client who ends up paying for such an opinion. Any dereliction in this regard might dilute our significance and exclusivity. When we consciously discharge our duties to meet with the genuine expectations of the stakeholders, our stature and rights get automatically preserved and cherished. Rights which flow from duties not done properly are not worth having.

Adherence to various standards governing the profession; ensuring proper documentation of work done and resorting to expression of opinion without fear or favour leaves no room for a gap in performance. Succumbing to pressure of a branch manager of a bank to complete an audit in undue haste or to classify certain NPAs as good debts may at best please him but undoubtedly erodes the image of the professional even in his mind. Losing sight of the significance of quality in work may result in short term gains to that professional but brings disrepute to the entire profession. If the nation’s interest is upheld and protected while serving a client, it brings greater glory to the profession and the brand image is enhanced by reinforcing stronger faith and instilling greater confidence.

The signature of any professional is an expression of credibility. So is the case with the signature of a member of our profession which is truly trusted and highly respected. The status of the signature of a person becomes elevated and turns out to be a precious one on acquiring professional qualification as a Chartered Accountant. Even if a miniscule section of the society perceives that the signature of a member of our profession is available for the asking or solely for a consideration that would be a dreadful scenario and could lead to erosion of goodwill which our forefathers have so strenuously built over six decades.

Ethical values

Some members of the profession strive and survive on account of the goodwill created by our forefathers. Many members contribute to and enhance such good-will by their exemplary conduct, impeccable integrity and qualitative delivery of services. Unfortunately, the conduct of a few has diminishing effect on the goodwill of the profession. We need to introspect as to which category we should belong to and the answer is obvious. Fee based approach in everything we do would be fatal in the long run whereas value based approach would enhance our reputation. Mahatma Gandhi said that there is enough for every one’s need but not for the greed. The Father of the nation also indicated that ‘ends’ do not justify the ‘means’. It might pay to be unethical in the short run, but in return one loses self-esteem and peace of mind, which is too precious a price one should dread to pay and suffer.

Lord T.B. McCauley said, “the measure of man’s real character is what he would do if he knew he would never be found out”. Everyone aspires to grow and reach greater heights. It will be nice to always bear in mind that ability may take us to the top but it requires character to stay there. Quality in service without compromising on ethical values begets not only prosperity in the long run but undoubtedly helps us to build image and command respect. In matters of innovation and empowerment, one should swim with the current, but in matters of values and principles, one should stand like a rock.

Challenging Environment

With the passage of time, business practices are getting corrupted. Government departments are difficult to deal with when straightforward approach is adhered to. The business philosophy and practices are degenerating in values due to which many frauds and scams are surfacing. There is lack of transparency and accountability in the usage of resources by the governments as well as entrepreneurs. Manipulations and fudging in matters of finance and accounts are resorted to for various reasons and more particularly for evading tax outflows. In such an environment it is a challenge for the accounting profession to discharge the duties upholding standards and values. A profession like ours owes it to the society to possess the courage of conviction and perform our role in the best interest of the economy in order to establish unblemished track record for the posterity to inherit.

The audit reports of C&AG on allocation of spectrum in the telecom sector as well as natural resources such as coal has brought in accolades from the public and created enormous awareness among the masses on the need for good governance and has served as a warning for those involved in the decision making process to be accountable. Many of our members have been instrumental in bringing out frauds and manipulations. The future is going to be tougher in this regard and all the same we need to gear up to face the challenge and ensure that there is no performance gap. No other profession can boast of having as proximate a role and nexus as ours with the economic development of our country. Let us reinvent the significance of our role in partnering, participating and partaking in building a credible economy in the incredible India.

Professional Social Responsibility (PSR)

A member of our profession is considered to belong to the elite segment of the Indian society. About 27% of the Indian population is perceived to be below the poverty line. We owe it to the society to contribute in uplifting the lives of the downtrodden and under privileged masses. The standing and respectability of the profession can touch lofty heights only if the profession is able to positively contribute to the socio-economic development of the society. Several measures can be resorted to as part of PSR initiatives and some of them can be readily spelt out. Firstly, ICAI and professional forums like BCAS can enhance the level of contribution in the policy formulations by various ministries of the Central Government and of the State Governments on socio economic reforms and their effective implementation. Secondly, senior members of the profession and other members with requisite exposure, aptitude and inclination, can plunge into public life in large numbers; accept positions such as trustees of public charitable trusts and institutions, become governing board members of educational, health care institutions and not for profit organisations, assume leadership in chambers of commerce, management and trade associations. Thirdly, every medium and large firm can establish a charitable institution and carry out activities to meet societal needs in a small way.

It is well known that ICAI has a Benevolent Fund for the members of the profession, which goes to the rescue of the distressed, in times of need. Another similar measure was conceptualised as ‘Fund for Education and Welfare of Students’ during 2006-07 but seemed to have been lost sight of down the line.(Please refer page 1186 of February 2007 Journal, The Chartered Accountant). If properly taken up, this fund would assist meritorious but poor students to be financially supported and counselled to pursue and qualify as members of our profession. CA. Prema earned wide acclaim by achieving All India First rank in the November 2012 examination in spite of hailing from a humble background with her father being an auto rickshaw driver in Mumbai. Many such students could be ably supported and made members of our profession. We should reach out to those bright students who might not otherwise take up higher studies and thereby change the profile of their families by the power of our professional qualification. This can be yet another measure worth pondering over to be acted upon as part of the PSR initiative.

Conclusion

As we continue our glorious journey, it’s time that we take stock of the socio-economic changes unfolding around us and adjust the course of our journey accordingly for larger benefit of the society and the nation. We may not have the ability to change the course of the wind but we can set the sail appropriately to proceed in the noble path we choose to progress. French philosopher Jean-Paul Sartre said that we have no destinies other than those we forge ourselves. Let us make the society feel proud of our profession and thereby justify our existence.

Nirav Shah

Lawyers’ Duties and Accountability

A story going the rounds is that the Chairman of a company after referring to the next speaker as a lawyer added “he is nevertheless a nice person.” But is the jibe deserved? Before passing judgement it would be appropriate to consider the duties a lawyer owes to his client, to his profession and to the Court, his accountability therefor and the conflicts which arise in discharging the separate and distinct duties. Recently, the emphasis has shifted to the lawyer’s duty to Society. Though one cannot ignore this duty it is a duty subordinate to his primary duties of accountability to his client, profession and to the Court. The meticulous performance of these duties with care and precision is itself the performance of his duty to Society. Though not normally referred to, there is a fifth and equally – if not more – important duty – his duty to himself.

Very often the lay person raises a question as to how a lawyer could defend a particular person or a particular action of his client which in the lay mind was indefensible. The Bar Council of India has framed a code of conduct to be followed by all advocates. One of the duties of an advocate is to accept a brief in the Courts or Tribunals in or before which he normally practices. If, however, his brief requires him to argue contrary to his beliefs and there is a conflict of duty to his client and to himself then, his duty to himself may justify his returning the brief. It is not for him to choose which is a good case and which is not. The central function of a lawyer is to represent his client and to say in legal parlance what the client would have said if he was to argue his own case and had the required legal acumen. James Boswell in his Life of Samuel Johnson records having asked the great man “What do you think of supporting a cause which is known to be bad?” Dr. Johnson’s reply was to the effect: “Sir, you do not know it to be good or bad till the judge determines it. You are to state facts clearly, so that your thinking or what you call knowing a cause to be bad must be from reasoning, must be from supposing your arguments to be weak and inconclusive …”

Lord Macmillan in “Law and Other Things” has said that the advocate by the rules of his profession has, theoretically at least no choice in the selection of the cases he takes up. He quotes Erskine as saying that if an advocate is permitted to say that he will not stand between the Crown and the subject arraigned in the Court on the basis of his opinion above the correctness of his client’s stand “from that moment the liberties of England are at an end.”

It is the duty of an advocate to uphold the interest of his client by all fair and honourable means without regard to any unpleasant consequences to himself or to any other. An issue which sometimes arises is whether in discharging this duty there would be a conflict with the advocate’s duty to the Court. Whilst he must uphold in all ways the interest of his client at the same time he must not put forward as a fact when he knows (as distinct from what he suspects) to be untrue. For example, if the client has told him that he has done something the advocate cannot urge that he has not done it though he would be justified in taking the stand that it is for the other side to prove that his client had indeed done the act as alleged by the other side. Many people take the view that this is a facetious distinction which lawyers draw. However, the rule of law requires that it is for the plaintiff or the prosecutor to establish his case with acceptable evidence and if the lawyer does not take this stand he would be cutting at the root of the rule of law. It is also urged that a lawyer’s duty to society requires that he should not defend someone who he believes to be guilty of what is alleged against him. Those who would so urge should ponder over whether if a man sentenced to death for murder falls sick whilst in jail should a doctor attend to him or decline to do so in the belief that Society would be well served by his early demise. A lawyer’s duty is to his client and to the Court and if one may say so to the law. In my opinion these override any amorphous duty to Society which is spoken of so glibly. An advocate’s loyalty is to the law and the law requires that no man should be punished without adequate evidence. The cynic may counter that it is fortunate that people are born whose moral standards are sufficiently flexible to enable them to practise the calling of law!

Section 126 of the Indian Evidence Act provides that except with the client’s consent a lawyer cannot disclose any communication made to him by the client or to reveal the contents of any document to which he has become privy in the course of his professional employment or disclose the advice tendered by him to his client. Contrary to this specific provision of law the activist, who champions the lawyers so called duty to Society, would urge that the lawyer must not keep secret his knowledge about an illegality committed by his client. In my view there is no such duty and the importance of complete and free communication between a lawyer and his client is itself for the welfare of Society at large.

An interesting issue arises when a client wants to know the consequences of his acting in a manner which is contrary to the law. It would appear that it is the lawyer’s duty to explain what would be the decision in law if the misdeed is discovered but he should in no way be a party to facilitate on such misdeed. A fine issue arises – is it the duty of the lawyer to tell the client that what he proposes to do is contrary to the law and he ought not to embark on the act. It would appear (though there may certainly be two views on the issue) that it is not for the lawyer to be a moralist but leave it to the client to decide whether knowing the consequences ethical and otherwise, of what he proposes to do, he should still go through with his earlier scheme. Here also the protagonist of “duty to Society” may take a contrary view.

An arguing Counsel owes a duty to his client and to the Court for attending the hearing of an appeal from the beginning to the end. It is not enough that the lawyer attends Court only at the time his turn comes to argue the case for his client and thereafter on completing the argument leaves the Court with some excuse or the other proffered to the judge. The lawyer’s defence is that he owes a duty to other clients for whom also he is to appear on the very day. I feel that unless the lawyer is present throughout the hearing of the appeal and has heard the arguments of the opposing Counsel he would not be able to give off his best to the client or to render full assistance to the Court. He should choose which case he will attend to and return the other briefs in good time or have the other hearing adjourned. In a witness action the position may be different.

Sometimes a possible conflict arises when a judge seeks Counsel’s opinion on a particular matter which is in issue between the contesting parties. If the lawyer was to express his opinion or what he believes to be the right position in law he may be acting adversely to his client’s interest. He would therefore be justified in politely declining the judge’s request to give his opinion. Some purist may contend that in taking this stand the lawyer is not discharging his duty to the Court. Though the lawyer’s duty to the client is certainly not more important than his duty to the Court, nevertheless the “inquisitive” judge should have realised that the duty of the lawyer is to argue his case and not to express his opinion on the issue involved. Undoubtedly, tact of a high degree is required in meeting such a situation. People must realise that what a lawyer believes and what he argues are not the same.

A related issue is to what extent the duty of a lawyer to the Court compels him to cite all possible decisions which he is aware of even though some of them may be contrary to what he is briefed to argue. Whilst the lawyer must bring to the notice of the Judge any judgement which is binding on the judge like that of the Supreme Court of India or of the Federal Court or the Privy Council (when the opinion of the Privy Council is as of a point of time when the same was binding on the Indian Courts). He will also have to disclose to the Court any judgement of the High Court of the state where he is arguing the matter as the same may be binding or if the judge wants to take a contrary view he may have to refer the matter to a larger Bench. It is not the duty of the lawyer to cite decisions rendered by other Courts which are not binding. It is for the opposing lawyer, if he so thinks fit, to bring such decisions to the notice of the Court. This shows that the lawyer can honour his duty both to the Court and to the client in respect of a particular matter without infringing either.

Sometimes a very piquant situation arises. A judge recuses himself from a case on the ground that one of the parties has “approached” him. Should the lawyer of the alleged defaulter also opt out of the case? In my opinion, he should first of all satisfy himself that indeed a representative on behalf of his client had approached the judge, with the client’s authority to do so. Unfortunately, there are today people who without being instructed by the client to do so approach a judge in a pending matter of which they are aware and then approach the client with the offer of procuring a favourable judgement. Once he is satisfied that the judge was indeed approached under his client’s instructions he should return the brief though it is possible that this may prejudice the client adversely if the brief is returned in the midst of a hearing. It would also show his client in poor light. This sort of situation really calls for a fine balance being drawn between the lawyer’s duty to the client and to the Court.

When discharging his duties to his client the lawyer often is faced with matching the same to his duty to the profession and to his co-professional. Though it may be in the interest of his client for the lawyer to interrupt the other side’s Counsel so as to distract him from his trend of thought or interfere with the flow of his arguments, it would be a breach of his duty to a co-professional and he must not indulge in it. I must say that I have found that in the southern states of India the respect for the right of the opposing professional to have full uninterrupted opportunity to express his views is far more evident than in the northern and, may I add, western states?

It is undoubtedly the duty of the lawyer to the Court always to be courteous and deferential to the judge but that does not mean he has to be obsequious. If for any reason it appears that the judge is acting un-reasonably and making comments which are wholly uncalled for either against the litigant or the lawyer or the legal profession it is his duty to stand up to the judge and, as politely as possible, to correct him. It is not the lawyer’s duty to the Court to submit to insults to himself or his profession or to fawn for petty favours. I remember an occasion when a judge was unreasonably giving a junior lawyer a tough time. As the Court rose for lunch a senior lawyer, who was wait-ing for his case to be called out got up and suggested that perhaps the junior lawyer deserved a more patient hearing. The judge – full marks to him – saw reason and his attitude changed post lunch. It is remarkable that the senior lawyer really did not know the junior at all but the incident shows the importance of stand-ing up to a judge even when it does not affect the lawyer personally.

It sometimes happens that a “succeeding” lawyer in the course of his argument takes a stand different from what his predecessor, who was then representing the client, had taken. If it is in the client’s interest for him to take a contrary stand he should do so but without in any way decrying or condemning the stand previously taken by the predecessor lawyer. In this manner he fulfills his duty both to the client and to the profession.

Sometimes a lawyer may feel that it would be advis-able for a client to consult another lawyer or even to brief another lawyer rather than himself. He should frankly advise the client to do what is in client’s interest though it may conflict with his own pecuniary interest. A lawyer is sometimes asked to recommend the name of a junior to assist him. The lawyer should either leave it to the client to choose the junior lawyer or suggest 3 or 4 names preferably not only from his chamber and leave it to the client to decide who should be briefed. This would fulfill the duty of the lawyer to his co-professional by not depriving a junior outside his chamber from being briefed.

In the practice of the profession sometimes peculiar situations arise which have a bearing on conflict of duties. It may happen that after a case is heard and decided the advocate reliably learns that the judgement was improperly procured. This would mean that even though the client may not himself be guilty of any improper conduct there was a miscarriage of justice. Is it the duty of the advocate in these circumstances to bring these facts to the notice of the Court for considering whether to order a retrial? The purist would undoubtedly say that it is advocate’s duty to do so but there may be practical difficulties.

An interesting instance of conflict of duties may arise when a lawyer accepts a directorship. It may happen in this way: the company of which he is a director may be confronted with a particular problem and looking to the facts of the case the company may have to adopt a particular stand in law and the director would have voted in favour of taking such a stand. In the light of this peculiar position his view of what is the correct position may get warped and he may not be able to render independent advice to another company facing a similar problem. For a similar reason, a lawyer who is a director of a company must not appear in Court for the company as he may not be able to maintain the sense of independence and detachment required of him. In similar vein a firm of solicitors, a partner of which is a director on the Board of a company, is not allowed to represent the company in Court. This is sometimes overcome by the solicitors firm interposing a dummy lawyer. But that is really a case of failure of duty to one’s conscience!

A common source of conflict is where each of two partners of a firm represents persons arraigned against each other. They build some sort of a Chinese wall to urge that they both function independently. However, there is no gainsaying the fact that there is bound to be at some stage a conflict of duties and the firm may tilt in favour of the client who is more important to it; namely, from whom it hopes to earn a larger fee in the long run.

It goes without saying that an advocate cannot be a party to procuring evidence by inducement. By procur-ing evidence the advocate may further the cause of justice but may he be guilty of breach of his duty to the Court or the profession and perhaps even to society. For example, a suit is filed by A claiming damages from B who had assaulted him. X was the only witness to the incident. When the matter is to be heard in Court X suggests to A’s lawyer that he may not come to give evidence and if he is summoned he may plead that he did not remember what exactly happened. He may slyly add that he could be induced to state the truth. If the lawyer spurns X’s suggestion it may mean that his client who was entitled in law to succeed may not be able to prove his case. On a strict view of the matter it would appear that the advocate is in breach of his duty to the Court and the profession if he suc-cumbs to the suggestion made by the witness. If he does not succumb to X’s demand is he in breach of his duty to the client because the client may fail in a cause where he deserved to succeed? The puritan will undoubtedly opine that upholding the process of law and justice is more important than an individual client’s obtaining of damages for the wrong done to him. On the other hand, one may think that it is reasonable to do a little wrong to achieve a higher good in the form of a person justly succeeding in the litigation launched by him. It appears that whichever way he acts the lawyer may later have pangs of conscience. A self saving action on the part of the lawyer may be to tell his client to contact X if he so deemed fit. Of course this would mean that the lawyer would have to live with the disconcerting fact that he, at least passively, was a party to “procuring” evidence.

An advocate undoubtedly owes a duty to his fellow professional: not to run him down or attempt to take over his brief. Does it mean that he should not appear in a matter in which his fellow professional is sued? The answer obviously is that his duty to his client, who claims relief against a professional brother, is higher than his duty to a fellow professional or to the profession. If a lawyer declines to appear against a brother lawyer it would mean that the affected party may not be able to find a lawyer to represent him.

Sometimes a client realises that he is bound to fail in his plea before the Court but he would like to postpone the evil day. It would appear that the advocate’s duty to the client permits him to obtain an adjournment on whatever grounds are available but without putting forward a false excuse. The fact that thereby there is a delay which is adverse to the interest of the other side does not mean that the advocate is in breach of his duty to the profession or to the Court.

The lawyer’s duty to the client does not extend to car-rying out all his instructions. For example it is not his duty to oppose the grant of an adjournment sought by the other side because his client says so or to urge an argument the client insists on even though the lawyer feels it would be counter productive or not ethical to do so, then, the advocate’s duty to himself, to the Court and to the profession must prevail. However, he should communicate his decision to the client in good time and he should give the client the option to brief another Counsel. In similar light is the case where the opposing side’s Counsel has slipped up. Should the advocate take advantage of that position? The classical view would be he should not. I do not know how far that is practical because surely it is not Counsel’s duty to say that his co-professional has made a slip in not pressing a particular point or not pressing it forcefully enough and the judge should consider the same.

I have referred above to a lawyer’s duty to Society. It would be apt to mention Society’s duty to “law.” Nowadays the media pronounces upon a case and lawyers comment on a case in progress. This may prejudice the interest of one of the litigants in the case. Society and all of us owe a duty to law and its fair administration and to desist from action which can conflict with a litigant’s right to a fair and free trial. I am conscious that if it were not for the interest taken by the media several matters of grave concern which involve prominent politicians and other personalities may have gone unattended to. Even so one should try to reconcile duties of the media to law and to Society.

Finally, does the advocate-writer of an article owe a duty to his reader not to bore him even though his personal vanity tempts him to continue? I should think so and so in deference thereto and to fulfill a higher duty I shall wind up this piece!

Nirav Shah

Export of Goods and Services – Realisation and Repatriation period for units in Special Economic Zones (SEZ)

Presently, there is no time limit for realisation and repatriation of export proceeds in respect of exports made by units in SEZ.

This circular provides that exporters in a SEZ must now realize and repatriate within a period of twelve months from the date of export the full value of goods/software/services exported by them. In case they require any extension of time beyond the above stipulated period they have to obtain specific permission of RBI.

levitra

Nirav Shah

2013 (30) STR 347 (Del) Delhi Chit Fund Association vs. Union of India

Whether services provided in relation to conducting a chit business is a taxable service u/s. 65B(44) of the Finance Act, 1994 inserted with effect from 1st July, 2012 ?

Facts:
The appellant, an association of chit fund companies based in Delhi operating under the Chit Funds Act, 1982. Notification No.26/2012-ST dated 20-06-2012 issued by the Government exempted services provided in relation to chit to the extent of 70% subject to the conditions as specified.

The appellant pleaded to quash the said notification in so far as it sought to subject the activities of business of chit fund companies to the levy of service tax to the extent of 30% of the consideration received for the services when the law itself provides that such services were not taxable at all in the first place and they contented that vide Explanation 2 to section 65B(44), the consideration charged for services of foreman in chit business, are also excluded from the charge of service tax. Further, the explanation provided in the Education Guide issued by the CBEC at para 2.8.2. also was not correct having regards to the proper interpretation of the statutory provisions.

Held:
Allowing the appeal, it was held that the function of an Explanation was to explain the meaning and effect of the main provision and to clear up any doubt or ambiguity in it. It’s the intention of the legislature which was paramount and a mere use of a label cannot control or deflect such a function. Any ambiguity or doubt in the interpretation of the exclusionary part of the definition of the “service” gets cleared up on a careful examination of the implications of Explanation 2. This Explanation was enacted only “for the purposes of this clause” and since it was placed below clause (c), strictly speaking it was relevant only for the purpose of the aforesaid clause. Further, the answer given at para 2.8.2. of the Education guide was also not correct having regards to the proper interpretation of the statutory provision. Hence, no service tax was chargeable on the service rendered by the foreman in a business of chit fund.

levitra

Nirav Shah

Board Instruction No.137/132/2010-ST dated 11-05- 2011 quashed

Board Instruction No.137/132/2010-ST dated 11-05- 2011 quashed

Facts
The
appellant was an Aircraft maintenance engineering training school
approved by Director General of Civil Aviation (DGCA) for providing
Aircraft maintenance engineering (AME) training and conducting
examination wherein the course was approved by the DGCA under relevant
statutory provisions of Civil Aviation Requirement (CAR). Based on the
Board’s Instruction No. 137/132/2010- ST dated 11-05-2011, the
department raised demand. The appellant contended that they issued a
certificate approved by DGCA which fully controlled such training
institutes by prescribing syllabus, regulating number of seats per
session, manner of conduct of exam etc. and that the instruction (supra)
was in contravention of section 65(105) (zzc) read with section 65(27)
of the Act and Notification dated 25-04-2011. The respondents contended
that the appellant did not issue any certificate, degree or diploma
recognised by law but only issued a certificate of course completion
that the AME course was not approved by DGCA but they only issued a
Certificate of Approval to impart training but not to issue any degree,
diploma or certificate recognised by law. In view thereof, the exclusion
provided in the definition of Commercial Training & Coaching was
not applicable to the appellant as their role was limited to train
candidates to appear for the examination conducted by the DGCA and that
DGCA itself did not qualify as an institute recognised by law. Revenue
also contended that the instructions were not binding on quasi-judicial
authorities and thus the writ remedy was not available to the appellant.

The DGCA in its counter affidavit stated that being a
subordinate office of Ministry of Civil Aviation, Government of India it
is a regulatory body in the field of civil aviation primarily dealing
with safety issues with respect to air transport services, enforcement
of civil air regulations, air safety and air worthiness standards. They
further stated that in accordance of the CAR, AME institutes were
required to issue course completion certificates to the students who had
successfully passed, the format of which was approved by DGCA and that
DGCA was not empowered to grant/recognise degree or diploma course
offered by any institute/organisation.

Held
After
perusal of the Act and Rules along with CAR, it was held that not every
institute could offer such course and impart training without the
approval as per the Act, Rules and CAR. The DGCA regulated the course
content offered by such institute and gave relaxation to the successful
candidates by way of grant of authority/license to render services of
aircraft repair and maintenance and to certify the aircraft’s
airworthiness. The Hon. High Court interpreted the expression
“recognised by law” to have a wide meaning and thus held that even if
the certificate/degree/diploma/qualification was not the product of a
statute but had approval of some kind in ‘law’, it would be considered
as exempt. The reasoning in the impugned instruction mixes up and
confuses ‘qualification’ with “a license to practice on the basis of the
qualification”. An educational qualification recognised by law would
not cease to be recognised by law merely because for practicing in the
field, a further examination held by a body is required to be taken. In
view thereof, the instruction, being contrary to section 65(27) and
notification dated 25/04/2011, was quashed.

[Note: Earlier, on
the above issue, an advance ruling was decided against the assessee in
CAE Flight Training (India) Pvt. Ltd. vs. Commission of Service Tax,
Bangalore 2010 (18) STR 785 (AAR). Similarly, the CESTAT Mumbai also
decided against the assessee in Bombay Flying Club vs. CST, Mumbai-II
2013 (29) STR 156 (Tri.-Mumbai). These decisions appear to have been
overruled by the above.]

levitra

Nirav Shah

2013 (30) STR 337 (SC) M/s. Tata Sky Ltd. vs. State of M.P And Others

Whether entertainment duty can be levied on the services of Direct to Home (DTH) Broadcasting on the basis of a notification? Held, No.

Facts:
The appellant provided services of DTH broadcasting under the Indian Telegraph Act, 1885 and the Indian Telegraphy Act, 1933 and discharged service tax thereon. In exercise of their powers, the State Government issued a notification dated 05-05-2008 fixing 20 percent entertainment duty in respect of every payment made for admission to an entertainment other than cinemas, videos cassette recorders and cable service and thus proceeded to demand entertainment duty from the appellant. The appellant filed a writ petition before the Hon. Madhya Pradesh High Court which dismissed the petition and upheld the said levy and demand thereof. The appellant therefore filed a petition before the Hon. Supreme Court against the said levy.

Held:
The Hon. Supreme Court held in favour of the appellant in view of the following observations:

The provisions of the Act were applicable only to place-related entertainment. In other words, the Act covered an entertainment which takes place in a specified physical location to which persons are admitted on payment of some charge. The legislative history and the amendments introduced by the state in the said Act further substantiated the above fact.

The activity of DTH Broadcasting was not covered by the provisions of section 3 read with section 2(a), 2(b) and 2(d) read with section 4 of the said Act and thus, the provisions of the Act cannot be extended to cover DTH operations carried out by the appellant. Further, it was elementary that a notification issued in exercise of powers under the Act should not amend the Act. Moreover, the notification merely prescribed the rate of entertainment duty at 20 percent in respect of every payment for admission to an entertainment other than cinema, video cassette recorder and cable service. The notification could not enlarge either the charging section or amend the provision of collection under section 4 of the Act read with the Rules. It was, therefore, clear that the notification in no way improved the case of the State. Lastly, if no duty could be levied on DTH operation under the Act prior to the issuance of the notification, then duty cannot also be levied under the said Act after the issuance of the notification.

levitra

Nirav Shah

Retrospective Amendment in MVAT Act – Validity

Introduction

There are a number of cases wherein the issue about validity of retrospective amendment in Fiscal Statues has been dealt with. One such situation arose under the Maharashtra Value Added Tax Act, 2002 (MVAT Act).

The background is that the State of Maharashtra has notified incentive schemes, popularly known as Package Scheme of Incentives (PSI). The schemes were notified from time to time in about 5 years interval.

A similar scheme was announced in the year 1993. Normally, the original unit coming up in the notified backward area is eligible for the benefits of such scheme/s. However, the Government also granted such benefits for expansion of units subject to compliance of certain requirements about minimum capital investment/increase in productions etc.

These units were issued Eligibility Certificate by the Implementing Agency like District Industries Centre and for sales tax purpose the Entitlement Certificate was issued by the Sales Tax Department. Based on such Entitlement Certificate, the eligible units were entitled to enjoy sales tax benefits by way of exemption from payment of tax or were given an option to have deferment facility, whereby they could collect the tax and pay the same to the Government after certain number of years as per the Scheme. The units had the option to choose the method, i.e. either exemption or deferment, for enjoying the benefits.

Pro-rata Method for Expansion
The issue arose where the unit was already holding Entitlement Certificate as an Original Unit (Existing Unit) and it was also granted further Entitlement Certificate for Expansion. The understanding of the Expansion Unit was that they were entitled to avail the benefit of Scheme for all the production of the unit, i.e. production relating to the Existing Unit as well as the Expansion.

However, the approach of the Sales Tax Department was that the Expansion unit can enjoy the benefit to the extent of ratio of Expansion. In other words, it was contemplated by theDepartment that out of the full production, only pro-rata production relating to the Expansion could enjoy PSI benefit. They clarified pro -rata method to work out such turnover by way of a circular. As per the said circular, unit can take benefit in proportion of capital increase to the total capital or production increase to the total production.

The issue was contested by the dealers since 2001 and in case of Pee Vee Textiles (App. No. 48 and others of 2000 dated 17.3.2001) MST Tribunal held that even in case of Expansion, the unit is entitled to enjoy benefit for the full production and the monetary limits should be adjusted accordingly. The issue was further contested before the Hon. Bombay High Court. The Hon. Bombay High Court in the case of Commissioner of Sales Tax vs. Pee Vee Textile (26 VST 281)(Bom) confirmed the decision of the Tribunal. The said judgment of the Hon. Bombay High Court was further confirmed by the Hon. Supreme Court in July 2009.

Retrospective Amendment
On this background, certain amendments were brought in the MVAT Act, in August 2009, by way of an Ordinance. Section 93 of the MVAT Act, 2002 was amended and other amendments were made providing the ratio method for pro-rata working in case of Expansion. Impliedly, the said amendment was effective from 01-04-2005. The period under BST Act was not touched and it remained governed by the above judgments of the High Court and Supreme Court. However, under VAT period effect was given from 01-04-2005.

Since the operation of the amendment was retrospective, it was challenged before the Hon. High Court on the ground of Constitutional Validity. Amongst others, following were the main contentions of the petitioners:

– There was no amendment in the original PSI and the changes are only in the Act which is not permissible.
– The retrospective amendment can be justified only when it is meant for removing the defect shown by the judiciary.
– The retrospective amendment will affect units harshly, since they have already enjoyed the benefits and now have no opportunity to pass on the burden to the buyers and the ultimate customers.
– There was conscious decision by the government from time to time not to implement the pro-rata method. The non-implimentation of section 41BB under BST Act and section 93 in the MVAT Act by not prescribing Rules for pro-rata method was stressed upon. It was shown that even the Rule for pro-rata method proposed in the draft Rules was withdrawn while publishing the Final Rules in 2005.

On behalf of government the submissions were as under:

– That there was intention to provide benefits on pro-rata method.
– There is no vested right to enjoy windfall benefits.
– In Pee Vee Textiles, the Hon. High Court confirmed the judgment of the Tribunal on the ground that inspite of having powers u/s. 41BB to provide pro -rata method, the same is not implemented by prescribing Rules. The legislature has now corrected the said position by the above retrospective amendment. Thus it is for curing the lacuna.

Judgment of the High Court in the case of Jindal Poly Films and Others (W.P.No.313 of 2010 and others dt. 10-10-2013).

After considering the arguments of both the sides, the Hon. High Court referred to a number of judgments about retrospective amendment in the Act. And the Hon. High Court observed that there is ample power for retrospective provision except that it should be reasonable. Like, if the levy is a surprise then it can be considered as invalid.

In particular facts of the above case, Hon. High Court felt that the amendment is not a surprise amendment, but it is to cure the basis of the judgment in the case of Pee Vee Textile. In a nutshell, the Hon. High Court has observed as under:

“32. Essentially, the issue before the Court is as to whether the validating legislation has cured the vice that was noted in the judgment of this Court. Alternately, whether the same judgment could have been rendered despite the amended provisions of the law. The judgment of the Division Bench in Pee Vee Textiles noted that the legislative intent embodied in Section 41BB of the Bombay Sales Tax Act, 1959 could not be effectuated in the absence of rules framed by the State Government prescribing the ratio for the grant of proportionate incentives. This anomaly has been corrected by the state legislature by the enactment of the Maharashtra Act 22 of 2009. The fact that a draft rule which had been formulated at an anterior point in time had not been converted into an operative piece of subordinate legislation cannot possibly override the power of the state legislature to enact legislation which falls within its legislative competence. There can be no estoppel against the legislature. It is legitimately open to the legislature to enact validating legislation with retrospective effect to cure a deficiency which was noted in the judgment of the Court as a result of which the legislative intent of granting incentives pro-rata could not be effectuated. The legislature has stepped in to cure the deficiency. The validating legislation and the amendment lay down the manner in which proportionate incentives would be computed. Such a course of action is legitimately open and cannot be regarded as being arbitrary or as violative of Articles 14 or 19(1)(g) of the Constitution. The principle of allowing pro-rata incentives subserves the object of the legislation. If the legislature has, as in the present case, determined that the purpose of the Package Schemes of Incentives should or would be achieved by allowing incentives to be computed on a proportional basis, that legislative assessment cannot be regarded as unconstitutional.”

The Hon. High Court accordingly upheld the retrospective validity and also justified levy of interest. However, the levy of penalty was held to be invalid for the period prior to the amendment. Accordingly, the Hon. High Court disposed of the petitions.

Nirav Shah

Penalties, Prosecution, Power to Arrest – Recent Amendments

Introduction:

Significant amendments have been made by the Finance Act, 2013 through introduction of provisions for imposing penalties on directors/ managers/etc. of a company and making certain offences cognisable thereby empowering tax authorities to arrest a person without warrant. These amendments which have far reaching implications, are discussed hereafter.

Penalty for failure to register:

Presently, u/s. 77 of the Finance Act, 1994 (‘Act’), penalty for failure to register within the due date, is the higher of the following:

? Rs. 10,000/- or

? Rs. 200/- per day during which the default continues.

Section 77 of the Act is amended with effect from 10-05-2013, to restrict the maximum amount of penalty for failure to register to Rs. 10,000/-. Though the penalty is still on the higher side, the amendment is a welcome one.

Penalty on directors, managers, secretary or other officers for certain contraventions by a company:

The Finance Act, 2011, with effect from 08-04-2011, made section 9AA of the Central Excise Act 1944 (‘CEA’) applicable to service tax. This section provides that if an offence is committed by a company (which includes a firm), the persons liable to be proceeded against and punished are:

• the company;

• every person, who at the time the offence was committed was in charge of and was responsible to the company for the conduct of the business except where he proves that the offence was committed without his knowledge or that he had exercised all due diligence to prevent the commission of such offence; and

• any director (who in relation to a firm means a partner), manager, secretary or other officer of the company with whose consent or connivance or because of neglect attributable to whom the offence has been committed.

In addition to the above, a new section 78A is introduced with effect from 10-05-2013, for imposing a financial penalty upto Rs. 1,00,000/- on directors, managers, secretary or other officers in charge of the company for specified contraventions committed by a company namely :

• evasion of service tax; or

• issuance of invoice, bill or challan without provision of taxable services contravening the provisions of the Rules prescribed under the Act;

• availment and utilisation of credit of taxes/ duty without actual receipt of taxable service or excisable goods either fully or partially in violation of the Credit Rules;

• failure to pay to the Government any amount collected as service tax beyond a period of six months from the date on which such payment became due.

The aforesaid persons would be liable to penalty only if:

• at the time of such contravention they were in charge of and responsible to the company for the conduct of business; and

• they were knowingly concerned with such contravention.

The terminology “in charge of and responsible to the company for the conduct of the business of the company” has been a subject of interpretation by the Supreme Court as well as High Courts from time to time. Some judicial considerations are given hereafter:

In Girdhari Lal Gupta vs. D N Menta, Collector of Customs (1971) 3 SCR 748, it was held that, the words “in charge of” must mean in overall control of the day to day business of the company or the firm;

In State of Karnataka vs. Pratap Chand 1981 (1) FAC 374, it was observed that, a partner who was not in overall control of the day to day business of the firm could not be proceeded against merely because he had a right to participate in the business of the partnership firm under the terms of the partnership deed.

In light of the foregoing, it would appear that, whether or not a director/manager/etc. of a company was “in charge/responsible”, would depend upon the facts and circumstances of a given case. Hence, it would be very difficult to lay down specific parameters as to the precise situations under which penalty would be imposable.

In this regard, it may be noted that for the contraventions mentioned in case of evasion, issuance of bogus invoices and non-payment amount collected as service tax, such persons may also be liable to be prosecuted in terms of section 89 of the Act read with section 9AA of CEA in addition to suffering a financial penalty u/s. 78A of the Act.

Further, in the absence of a corresponding amendment in section 80 of the Act, the defense of “reasonable cause” available under the said section would not be available against imposition of penalty u/s. 78A of the Act.

Failure to pay tax collected beyond 6 months – maximum imprisonment increased from 3 years to 7 years:

Presently, failure to pay to the Government any amount collected as service tax beyond a period of six months from the date on which such payment became due is a punishable offence. The quantum of punishment for this offence is increased with effect from 10-05-2013. Section 89 of the Act, as amended, prescribes the quantum of punishment separately in respect of first offence and second offence and also in cases where amount exceeds Rs. 50 lakh and other cases. The quantum of punishment for various offences as applicable from 10-05-2013 is summarised in the Table at the end:

Cognizance of offences and power to arrest:

Amendments in brief:

Significant amendments are made with effect from 10-05-2013 by introducing provisions relating to arrest of persons for offences under the Act. These provisions are summarised hereafter :

Offences are divided into two categories viz:

• Cognisable offences i.e. where the person can be arrested without ‘warrant’; and

• Non-cognisable offences [i.e. offences other than the above].

Failure to pay tax collected beyond 6 months from the due date where the ‘amount’ exceeds Rs. 50 lakh is the only cognisable offence. All other punishable offences (viz. knowingly evading service tax, availing bogus credits, supplying false information, etc.) are non-cognisable offences.

If the Commissioner of Central Excise (‘CCE’) has reason to believe that any person has committed an offence u/s. 89 of the Act where the ‘amount’ exceeds Rs. 50 lakh he may by general or special order authorise any officer of Central Excise not below the rank of Superintendent of Central Excise to arrest such person.

Where a person is arrested for any cognisable offence, every officer authorised to arrest a person shall inform such person of the grounds of arrest and produce him before a magistrate within 24 hours.

• In the case of a non-cognisable and bailable offence, the Assistant/Deputy Commissioner, shall for the purpose of releasing an arrested person on bail or otherwise have the same powers and be subject to the same provisions as an officer in charge of a police station has, and is subject to u/s. 436 of the Code of Criminal Procedure Code, 1973 (‘CrPC”).

• All arrests shall be carried out in accordance with the provisions of the CrPC.

Some considerations under Central Excise:

Provisions relating to power to arrest have been existing under Central Excise/Customs laws. Some considerations under the said laws are set out hereafter. The same could serve as a useful guide for the purpose of the service tax.

Powers to arrest:

U/s. 13 of CEA, an Excise Officer (EO) not below the rank of Inspector, is empowered to arrest a person whom they have “reason to believe” to be liable to be punished under provisions of CEA. Such arrest can be only with prior approval of the Commissioner.

EO can arrest and inform the concerned person as to the ground of arrest. The person arrested has to be forwarded to the Magistrate and must be produced before a Magistrate within 24 hours. The Magistrate may grant the bail on bond or refuse the bail and remand him to custody. Bail is at the total discretion of Court.

As per Section 50 of CrPC, a person arrested should be informed full particulars of the offence and his rights about the bail.

In Sunil Gupta vs. UOI (2000) 118 ELT8 (P&H), it was held that, even if offences under Central Excise are not cognisable, EO duly empowered u/s. 13 of CEA can arrest a person without a warrant.

In Rajni vs. UOI (2003) 156 ELT 28 (All), it was observed that, powers and duties of EO are not parallel to power of Station House Officer of the police station. As per section 155 of CrPC, investigation can be made only with order of Magistrate. EO has to follow provisions of CrPC as well as regards the arrest, or filing of complaint.

As per section 155 of CrPC, a police officer cannot investigate a non – cognisable case without the order of a Magistrate, A police officer cannot arrest a person who has committed a non-cognisable offence, without a warrant, as per section 2(1) of CrPC.

However, these restrictions are only to police officers. Section 13 of CEA confers substantive powers of arrest. These powers can be exercised by a duly authorised EO without a warrant of arrest. [Refer Sunil Gupta vs. UOI (2000) 118 ELT 8 (P&H)].

Arrest can be made only as per the provisions of section 46 of CrPC. Under this section, the person making arrest shall actually touch or confine the body of person to be arrested, unless the persons submit to the custody. If he resists the arrest, all necessary means may be applied to effect the arrest. However, this does not give right to cause death of a person, unless the accused of the offence is punishable to death or with imprisonment for life.

Arresting authority should make all efforts to keep a lady constable present. But in circumstances if a lady constable is not available or delay in ar-rest would impede the course of investigation, arresting officer, for reasons to be recorded in writing, can arrest a lady for lawful reasons at any time of day or night, even in absence of a lady constable [State of Maharashtra vs. Christian Community Welfare Council 2003 AIR SCW 5524.]

EO can make enquiry even after the arrest. In Badaku Joti Savani vs. State of Mysore – AIR 1966 SC 1746, it has been held by the Supreme Court that, though EO has the powers of a police officer, he is not a “police officer” unless he has powers to lodge a report u/s. 173 of CrPC. Statements made before EO even after arrest are not hit by section 25 of the Indian Evidence Act and these statements can be used as evidence against the accused.

Procedure after arrest:

The person arrested has to be forwarded to the EO who is empowered to send the arrested per-son to a Magistrate. If such empowered EO is not available within reasonable distance, the person may be sent to officer-in-charge of the nearest police station. Superintendent of CE has been empowered for this purpose. [Section 19 of CEA].

EO of the rank of Superintendent or above will make enquiry into the charges against the person arrested. While making enquiry, he has the same powers as an officer–in–charge of a police station [Section 21(1)(b) of CEA]. If he is of the opinion that there is sufficient evidence or reasonable ground of suspicion against the accused person, he can forward the person to Magistrate for bail or custody, [Proviso (a) to Section 21(2) of CEA].

EO making arrest has powers to release a person on executing a bond with or without sureties, and make a report to his superior officer. He can do so if it appears to him that there is no sufficient evidence or reasonable ground of sus-picion against the accused person [Proviso (b) to section 21(2) of CEA]. Superintendent of CE and officers above him have been empowered for this purpose vide Notification No. 9/99-CE(NT) dated 10-02- 1999. However, if he is of the opinion that there is sufficient evidence or reasonable ground of suspicion, he shall either admit him to bail to appear before a Magistrate having jurisdiction in the case or forward him in the custody of such Magistrate [Proviso (a) to section 21(2) of CEA].

Section 20 of CEA prescribes that the police officer shall either admit him to bail to appear before a Magistrate having jurisdiction, or in default of bail, forward him in the custody of such Magistrate. The arrested person must be produced before a Magistrate within 24 hours of the arrest.

Granting ‘Bail’:

‘Bail’ means a “security for prisoner’s appearance, on giving which he is released pending trial”. If offence is ‘bailable’, grant of bail is automatic and can be given by a police officer in charge of a police station or by a Court, on bond or with-out bond. Court has no discretion in the matter. In case of non–bailable offence, accused can be released on bail, unless the offence is punishable with death or imprisonment for life, Court has discretion whether to release on bail or not in respect of non–bailable offences.

The considerations which normally weigh with the Court in granting bail in non–bailable offences are basically – (a) nature and seriousness of offence (b) character of the evidence (c) circumstances which are peculiar to the accused (d) a reasonable possibility of the presence of the accused not being secured in the trial (e) reasonable apprehension of witnesses being tampered with (f) larger interest of public or State and (g) other similar factors which may be relevant in the facts and circumstances of the case [Jayendra Saraswathi Swamigal vs. State of Tamil Nadu AIR 2005 SC 716 (SC 3 Member Bench)].

The basic rule is in favour of granting a bail ex-cept where the course of justice being affected, gravity or heinous nature of the crime, risk of non appearance at the trial, influencing or intimidation of witnesses and similar other possibilities exist [State of Rajasthan vs. Balchand AIR 1977 SC 2447].

In Chaman Lal vs. State of UP 2004 AIR SCW 4705, it was considered that Court dealing with the bail application should be satisfied as to whether there is a prima facie case, but exhaustive exploration of the merits of case is not necessary. It is necessary for the Court dealing with application for bail to consider among other circumstances, the following factors before granting bail – (a) Nature of accusation and severity of punishment in case of conviction and nature of supporting evidence (b) Reasonable apprehension of tampering the witness or apprehension of threat to the complainant (c) Prima facie satisfaction of the Court in support of the charge.

Since the words used in section 20 of CEA are “shall admit the arrested person to bail”, it was argued that the Magistrate must release the person on bail. He has no power to keep the person in judicial custody, if he gives necessary bail bond. There were divergent opinions about whether Magistrate can detain him or he must release the arrested person on bail. Finally, in Director of Enforcement vs. Deepak Mahajan (1994) 70 ELT 12 (SC) Supreme Court has held that the Magistrate has jurisdiction u/s. 167(2) of CrPC to authorise detention of a person arrested under Customs Act etc. as provisions are identical. Thus the Magistrate may grant the bail on bond or refuse the bail and remand him to custody. Bail is at the total discretion of the Court.

In Sankarlal Saraf vs. State of West Bengal (1993) 67 ELT 477 (Cal), a division bench has held that power to grant bail, by necessary implication, includes power to refuse bail, Thus, Magistrate can refuse bail and order custody, police, jail or otherwise.

As per section 167 (2) of CrPC, a person can be kept in judicial custody for 60 days. If investigations are not completed within 60 days, the person arrested should be released on bail. The period is 90 days when offence is punishable with death, imprisonment for life or imprisonment of 10 years or more.

Section 438 of CrPC makes provision for “anticipatory bail”. Court should grant or refuse bail after exercising its judicial discretion wisely [Director of Enforcement vs. PV Prabhakar Rao (1997) AIR 1997 SC 3868 (3 Member Bench) – quoting Gurbaksh Singh vs. State of Punjab (1980) AIR 1980 SC 1632 (SC Constitution Bench).]

Conclusion

The amendments relating to penalties, prosecution & powers of arrest discussed above have been a subject of widespread expression of concerns by the trade & industry and the tax paying fraternity inasmuch as the provisions could be misused to cause undue harassment by the tax authorities.

In para 3 of TRU Circular No DOF No. 334/3/2013 TRU dated 28 -02-2013, it is clarified that policy wing of CBEC will issue detailed instructions in due course of time. It is felt that CBEC should issue a draft circular and seek views of trade & industry and all affected persons before finalising such instructions.

Table —Summary of Punishment for various offences

Nirav Shah

Dilip Sambhaji Shirodkar vs. ITO ITAT “D” Bench, Mumbai Before P.M.Jagtap (A.M.) and Dr S.T.M. Pavalan (J. M.) ITA No.8899/Mum/2010 Assessment Year: 2006-07. Decided on 12.06.2013 Counsel for Assessee/Revenue: Jitnedra Jain & Sachin Romani / Rajarshi Dwivedy

Section 69 – Acquisition of a flat in lieu of the surrender of a tenancy right – Existence of difference in value between consideration for tenancy right acquired and the value of the new flat received in lieu thereof not sufficient ground for making addition.

Facts:
The assessee was an individual engaged in the occupation of goldsmith. In his return of income he had declared a total income at Rs. 0.80 lakh. The AO, in assessment made u/s.143(3) found that during the year under consideration the assessee had purchased a property worth Rs. 50.35 lakh. The AO treated this impugned investment as unexplained and made an addition of Rs.50.35 lakh u/s.69. On appeal, the CIT(A) confirmed the action of the AO.

Before the tribunal, the assessee submitted that he had acquired tenancy right as per Agreement dated 09-04-2001 for a sum of Rs. 4 lakh. Thereafter, pursuant to the agreement dated 07-10-2005, the assessee was allotted a flat in another building in lieu of surrender of his tenancy right. The value of the flat allotted in lieu of surrender of tenancy right was Rs. 50.35 lakh as per the valuation done by the Stamp Duty Authorities, while registering the agreement. He further submitted that the consideration on the surrender of the tenancy rights, equal to the value of the new flat, stood fully invested in a residential flat, the Long Term Capital Gain arising on the said transaction was not chargeable to tax u/s.54F. The contention of the revenue was that the assessee had not been able to prove that he had received the flat by virtue of the surrender of tenancy rights.

Held:
The tribunal agreed with the assessee that the agreement dated 07-10-2005 clearly indicated that the new flat was acquired by the assessee in lieu of surrender of his tenancy right in the old building. The perusal of the agreement dated 09-04-2001, also indicated that the old tenants transferred the tenancy rights in respect of the said property to the assessee for a consideration of Rs. 4 lakh. Secondly, as regards the reasoning of the CIT(A) that the acquisition value of Rs. 4 lakh had not been paid by the assessee, the tribunal found merit in the contention of the assessee that the same had been by way of constructive payment made by the builder on behalf of the assessee, which according to it was not a new practice of the developer in business of construction industry. Thirdly, regarding the finding of the lower authorities as to the difference in values between the consideration for relinquishment of rights by the old tenant (Rs.4 lakh) and the market value of the new flat (more than Rs.50 lakh), the tribunal opined that it was beyond the purview of the lower authorities to suspect a transaction solely on the ground of adequacy/inadequacy of consideration in the absence of any other corroborating evidence and thereby making any adverse inferences. Further, the value as adopted by AO was based on the valuation determined by the stamp duty authorities while registering the agreement dated 07-10-2005. Therefore, it held that mere suspicion without evidence on record could not be the basis for making an addition to income u/s. 69 and hence, the addition made was deleted.

levitra

Nirav Shah

Journal

Brieficles

Resources

About

Reach Us